Pre-Money vs Post-Money SAFE Notes: What Australian founders need to know

SAFEs streamline the fundraising process by postponing valuation debates until a future funding round. However, understanding the distinction between pre-money and post-money SAFEs is critical, as it directly impacts founder dilution and investor ownership.

In this article, we’ll break down what a SAFE note is, explain the differences between pre-money and post-money SAFEs, provide a worked example, and outline what founders should keep in mind when negotiating terms.

TL;DR:

• SAFE Notes 101: A flexible tool for early-stage fundraising, exchanging investment for future equity.
• Pre-Money vs Post-Money: Pre-money SAFEs calculate investor ownership before new investments, leading to less dilution for founders. Post-money SAFEs include all investments, which can result in more dilution.
• Founder vs Investor Friendly: Pre-money SAFEs are more founder-friendly but less common; post-money SAFEs are standard and preferred by investors.
• Spot the Difference: Look for terms like “Fully Diluted” or “Company Capitalisation” and check if they exclude or include the SAFE.
  • Excluding = Pre-Money SAFE
  • Including = Post-Money SAFE
• Seek Expert Help: Always consult an experienced startup lawyer to avoid costly mistakes.

1. What is a SAFE Note?

A SAFE is an agreement where investors provide funding in exchange for a promise of equity at a future priced round. This structure avoids the need to determine the company’s value upfront, making it faster and cheaper than a priced round.

In the U.S., SAFE notes have standardised templates, but in Australia, there’s no universal standard. While the Australian Investment Council offers a widely used post-money SAFE template (here), SAFEs in Australia are often customised.

2. Pre-Money vs Post-Money SAFEs

Pre-Money SAFE

• Definition: Calculates the investor’s ownership percentage based on the company’s valuation before the SAFE investment and any subsequent financing rounds.
• Impact: The SAFE investor can be diluted by subsequent SAFEs and other financings before conversion.
• Outcome: More favorable to founders, as it results in less dilution of their ownership.

Post-Money SAFE

• Definition: Calculates the investor’s ownership percentage based on the company’s valuation after accounting for all SAFEs and other convertible securities.
• Impact: Protects the SAFE investor’s ownership percentage from dilution by subsequent SAFEs before conversion.
• Outcome: More favorable to investors, as it provides clarity on ownership and can result in more dilution for founders.

How to Identify the Type of SAFE

• Look for Definitions: Check the definition of “Fully Diluted” or “Company Capitalisation” in the agreement.
  • “Excluding” the SAFE in these definitions typically means it’s a Pre-Money SAFE.
  • “Including” the SAFE indicates a Post-Money SAFE.

Current Trend in Australia

• Post-money SAFEs are the standard in Australia because they reduce uncertainty for investors regarding their ownership stake.

Why Do I Need to Know This?

Beware of Mislabeled Templates

There are many SAFE templates circulating among founders that are mislabeled or poorly drafted. Sometimes, a template labeled as a “Pre-Money SAFE” is actually a “Post-Money SAFE” due to the definitions used within the document.

Using a mislabeled or misunderstood SAFE can lead to unintended dilution or ownership consequences. For example, I recently discovered that a well-known public SAFE template was mislabeled as a pre-money SAFE when, in fact, it was post-money. Founders and investors who used it without realising the discrepancy could face unexpected dilution or ownership changes.

The Blind Leading the Blind

Founders often share templates and documents without fully understanding the legal implications. This “blind leading the blind” scenario can result in costly mistakes that are difficult to unwind later.

Why You Need to Know This

• Protect Your Ownership: Misunderstanding your SAFE terms can lead to more dilution than expected.
• Avoid Legal Pitfalls: Incorrectly using templates can cause legal complications down the line.
• Make Informed Decisions: Knowing the differences empowers you to negotiate better terms.

3. Worked Example: Pre-Money vs Post-Money SAFEs

Let’s use a scenario to illustrate the differences.

Timeline:

• June 2022: Example Startup Pty Ltd raises $1 million via a SAFE note at a $5 million valuation cap.
• June 2023: The company raises another $750,000 via a second SAFE note at a $10 million valuation cap.
• August 2024: The company raises $5 million via a priced equity round at a $20 million pre-money valuation.

Scenario 1: First SAFE Only

Pre-Money SAFE Investor:

• Ownership Calculation:
  • Ownership Percentage = Investment Amount / (Valuation Cap + Investment Amount)
  • Ownership Percentage = $1,000,000 / ($5,000,000 + $1,000,000) = 16.67%

Post-Money SAFE Investor:

• Ownership Calculation:
  • Ownership Percentage = Investment Amount / Valuation Cap
  • Ownership Percentage = $1,000,000 / $5,000,000 = 20%

Dilution Impact:

• Founders’ Dilution:
  • Pre-Money SAFE: Founders give up 16.67% to the SAFE investor.
  • Post-Money SAFE: Founders give up 20% to the SAFE investor.
• Difference:
  • Additional dilution with a Post-Money SAFE: 3.33%
• Dollar Value:
  • At a $20 million valuation: 3.33% × $20,000,000 = $666,000 in additional dilution for founders.

Scenario 2: Two SAFEs

SAFE Investors:

1. First SAFE Investor ($1 million at $5 million cap)
2. Second SAFE Investor ($750,000 at $10 million cap)

Pre-Money SAFEs:

• First SAFE Investor Ownership:
  • Ownership Percentage = $1,000,000 / ($5,000,000 + $1,000,000 + $750,000) = $1,000,000 / $6,750,000 ≈ 14.81%
• Second SAFE Investor Ownership:
  • Ownership Percentage = $750,000 / ($10,000,000 + $1,000,000 + $750,000) = $750,000 / $11,750,000 ≈ 6.38%
• Total Dilution to Founders:
  • 14.81% + 6.38% = 21.19%

Post-Money SAFEs:

• First SAFE Investor Ownership:
  • Ownership Percentage = $1,000,000 / $5,000,000 = 20%
• Second SAFE Investor Ownership:
  • Ownership Percentage = $750,000 / $10,000,000 = 7.5%
• Total Dilution to Founders:
  • 20% + 7.5% = 27.5%

Dilution Impact:

• Additional Dilution with Post-Money SAFEs:
  • 27.5% (Post-Money) – 21.19% (Pre-Money) = 6.31%
• Dollar Value:
  • At a $20 million valuation: 6.31% × $20,000,000 = $1,262,000 in additional dilution for founders.

4. Which is Better?

Most Founder-Friendly: Pre-Money SAFEs

• Pros:
  • Less dilution for founders at the time of conversion.
  • Potentially more favorable ownership retention for existing shareholders.
• Cons:
  • Less certainty for investors regarding their final ownership percentage.
  • May be less attractive to experienced investors.

Most Investor-Friendly: Post-Money SAFEs

• Pros:
  • Provides investors with clarity and protection against dilution from subsequent SAFEs.
  • Aligns with standard practices in Australia.
• Cons:
  • Results in more dilution for founders.
  • May reduce founders’ control over the company.

Reality Check:

• If you’re raising capital from experienced investors, expect them to prefer post-money SAFEs.
• Insisting on a pre-money SAFE may lead investors to adjust other terms (e.g., lower valuation caps) to mitigate their risk and offset the difference.

5. Practical Tips for Founders

• Spot the SAFE Type:
  • Excluding the SAFE in definitions like “Fully Diluted” or “Company Capitalisation” indicates a Pre-Money SAFE.
  • Including the SAFE suggests a Post-Money SAFE.
• Know Your Numbers:
  • Use cap table modeling to understand how different SAFEs affect your ownership under various scenarios.
  • Be prepared with different dilution scenarios to make informed decisions.
• Seek Legal Advice:
  • Engage an experienced startup lawyer to review SAFE terms – Tip: Talk to at least 3 before making a decision and ask potential lawyers how many SAFEs they’ve handled in the last six months. (Great lawyers do more than just draft documents, they guide you on what is market standard and what is important to focus on and that can only be done if they have enough recent experience with the topic you are working on).
  • The cost of getting it wrong can be significant in terms of ownership and control.
  • Two excellent startup lawyers to consider for SAFE note advice are Xavier Keary at Gilbert + Tobin and Claire Thompson at Herbert Smith Freehills. (Disclaimer: I have no financial relationship with either. I simply believe in sharing trusted recommendations to save founders time and ensure they work with reputable service providers.)

Final Thoughts

SAFE notes are powerful tools for early-stage fundraising, but their structure has significant implications for founders. Understanding the nuances between pre-money and post-money SAFEs helps you negotiate fair terms and make informed decisions.

Remember: Investors value predictability. While pre-money SAFEs are more favorable to founders, they may be less attractive to investors seeking certainty in their ownership percentage. Balancing your needs with investor expectations is key to a successful fundraising round.

Warwick Donaldson is the author of the Aussie Startup Capital Nerd and specialises in providing hands-on capital raising support services for Aussie startups.

• The information provided in this article is intended for companies and startups and is not directed towards investors. Any statements or representations are general information only and do not take into account your personal objectives, financial situation or needs.