Post-Money SAFEs: What Founders Need to Know About Dilution Risks

SAFEs have become one of the most common ways for early-stage startups to raise capital. But not all SAFEs are created equal. The difference between a pre-money SAFE and a post-money SAFE can mean the difference between keeping control or being unexpectedly diluted for the founders.

The Adoption of SAFEs

In 2013 Y Combinator introduced Simple Agreements for Future Equity (SAFEs) to replace convertible notes and simplify startup investing. Under this instrument, an investor provides funding upfront in exchange for the right to receive equity in the company upon a future “trigger event,” typically a priced investment round or liquidity event.

SAFE conversion terms are usually based on a valuation cap (the maximum company valuation to convert) and/or a discount rate (a percentage reduction to the share price in the priced round). If both apply, the investor benefits from whichever results in a lower price per share and more shares for them.

SAFEs quickly rose in popularity due to their simplicity and lower transaction costs compared to convertible notes or priced rounds. They remain widely used today, particularly in seed rounds. Y Combinator accelerated adoption by making template documents and user guides freely available online, allowing founders and investors to execute SAFEs with no legal support.

The Shift to Post-Money Valuation

In 2018, Y Combinator published a post-money SAFE, replacing the pre-money SAFE they had been distributing for the past 5 years. The critical difference lies in how company capitalization is calculated upon conversion:

1. Pre-money SAFE - the valuation is calculated before new investments are added. Outstanding SAFEs are excluded from the calculation, and investor ownership is only determined at conversion.

2. Post-money SAFE - the valuation is calculated after new investments are added. Outstanding SAFEs are included in the calculation, fixing the investor’s ownership percentage at the time of investment.

Y Combinator’s asserts that the pivotal change to post-money SAFEs was to provide certainty on the investor equity percentage which benefits both investors and founders alike. While this cap table clarity is valuable, it does fail to acknowledge one serious implication - pre-money SAFEs allow investors to lock in their percentage without risk of dilution from other convertible investments entered pre-conversion, leaving the founders to absorb the dilution risk.

The Risk for Founders

The risks are most apparent when founders raise multiple rounds using SAFEs (“stacking”).

1. With pre-money SAFEs, investors dilute one another, as well as the founders.

2. With post-money SAFEs, investors do not dilute one another - only the founders bear the dilution.

As a result, founders who raise successive rounds through post-money SAFEs often discover at conversion that their ownership has fallen significantly more than anticipated due to inherent dilution protection offered to the SAFE investors.

Since post-money SAFEs have become the default instrument and stacking SAFEs is a common practice, founders must carefully track all outstanding SAFEs and the equity promised to each investor. Otherwise, the perceived benefits of SAFEs — speed and simplicity — can be outweighed by unexpected dilution when conversion occurs.

Conclusion

SAFEs remain an efficient and useful fundraising instrument, particularly for early-stage companies. However, founders should be aware of the material differences between pre-money and post-money SAFEs and carefully evaluate the dilution impact before signing. What appears to be a quick and simple way to raise funds can have significant long-term consequences for ownership and control.

While post-money SAFEs provide clarity on investor equity, they often do so at the expense of founders, making them strongly investor friendly. It is therefore unsurprising that Y Combinator, as both a leading accelerator and venture capital firm, now promotes post-money SAFEs as the standard financing instrument.

At Gosai Law, we regularly advise startups and investors on structuring early-stage financing. If you are considering raising capital through SAFEs or other instruments, our team can help you navigate the terms, avoid unexpected dilution, and protect your long-term ownership interests.