{"id":27185,"date":"2024-01-04T09:32:38","date_gmt":"2024-01-04T14:32:38","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=27185"},"modified":"2024-09-25T18:03:03","modified_gmt":"2024-09-25T23:03:03","slug":"safe-notes","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/","title":{"rendered":"SAFE Notes Explained: Definition, Calculations, Excel Examples, and Whether They\u2019re \u201cUnsafe\u201d for Startups"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">SAFE Notes Explained: Definition, Calculations, Excel Examples, and Whether They\u2019re \u201cUnsafe\u201d for Startups<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/#Part_1_SAFE_Notes_in_a_Seed_Round\">Part 1: SAFE Notes in a Seed Round<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/#Part_2_SAFE_Note_Conversions_in_a_Series_A_Round_Valuation_Caps_and_Conversion_Discounts\">Part 2: SAFE Note Conversions in a Series A Round (Valuation Caps and Conversion Discounts)<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/#Part_3_How_an_Options_Pool_Complicates_SAFE_Notes_Even_More\">Part 3: How an Options Pool Complicates SAFE Notes Even More<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/safe-notes\/#Part_4_Are_SAFE_Notes_Worth_It\">Part 4: Are SAFE Notes Worth It?<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>SAFE Notes Definition:<\/strong> With SAFE Notes (\u201cSimple Agreement for Future Equity\u201d), startup investors contribute capital but do <u>not<\/u> receive direct ownership in the startup right away; instead, they receive their shares later, when the company raises its first \u201cpriced round\u201d based on a specific investment amount and agreed-upon valuation.<\/p><\/blockquote>\n<p>With SAFE Notes, just like with <a href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/convertible-notes\/\" target=\"_blank\" rel=\"noopener\">convertible notes<\/a>, the startup co-founders and the investors do not necessarily need to agree on a valuation or many other terms that are part of the standard term sheet.<\/p>\n<div class='code-block code-block-9' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/22172829\/vc-tile.png\" alt=\"Venture Capital & Growth Equity Modeling\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Model and Value Startups, Understand Cap Tables, and Prepare for VC Interviews<\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Evaluate companies and deals like a pro<\/h4>\n              <p>You\u2019ll understand cap tables, startup\/growth valuations, and exits<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Master financial modeling<\/h4>\n            <p>You\u2019ll build forecasts and analyze metrics for tech and biotech startups<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 9 case studies<\/h4>\n            <p>You\u2019ll learn the numbers and how to make investment recommendations\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/venture-capital-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Venture-Capital-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div>\n<\/div>\n\n<p>However, SAFE Notes may also create <strong>long-term problems<\/strong> for startups because of disputes about future ownership and how to handle their conversion into shares.<\/p>\n<p>Also, in many cases, SAFE Notes <em>do<\/em> set an effective valuation via a \u201cvaluation cap,\u201d and they can create awkward situations if the startup fails because they are \u201cin-between\u201d traditional debt and equity.<\/p>\n<p>You can get our simple SAFE Notes Excel model and presentation slides and read this entire tutorial in written format below:<\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Startups-VC\/SAFE-Notes-Example.xlsx\" target=\"_blank\" rel=\"noopener\">SAFE Notes \u2013 Excel Model (XL)<\/a><\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Startups-VC\/SAFE-Notes-Slides.pdf\" target=\"_blank\" rel=\"noopener\">SAFE Notes \u2013 Presentation Slides (PDF)<\/a><\/p>\n<h3><strong>Video Table of Contents:<\/strong><\/h3>\n<p><strong>1:54:<\/strong> Part 1: SAFE Notes in a Seed Round<\/p>\n<p><strong>3:26: <\/strong>Part 2: Conversions in the Series A (Caps and Discounts)<\/p>\n<p><strong>8:54:<\/strong> Part 3: How an Options Pool Makes It Even Worse<\/p>\n<p><strong>10:32:<\/strong> Part 4: Are SAFE Notes Worth It?<\/p>\n<p><strong>12:39:<\/strong> Recap and Summary<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_1_SAFE_Notes_in_a_Seed_Round\"><\/span><strong>Part 1: SAFE Notes in a Seed Round<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If a startup raises capital via SAFE Notes in a Seed Round, <strong>nothing changes<\/strong> with the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/capitalization-table\/\" target=\"_blank\" rel=\"noopener\">capitalization table (\u201ccap table\u201d)<\/a> because the investors do not receive direct ownership.<\/p>\n<p>So, if two groups invest $2 million via SAFE Notes, and the co-founders own 90% with the employees owning 10%, the ownership percentages remain 90% and 10% after the deal:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27186 size-full\" title=\"SAFE Notes in a Seed Round\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed.jpg\" alt=\"SAFE Notes in a Seed Round\" width=\"1786\" height=\"688\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed.jpg 1786w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed-300x116.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed-1024x394.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed-768x296.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164037\/01-SAFE-Notes-Seed-1536x592.jpg 1536w\" sizes=\"(max-width: 1786px) 100vw, 1786px\" \/>\u00a0There are terms associated with these SAFE Notes \u2013 namely the <strong>valuation cap<\/strong> and <strong>conversion discount<\/strong> \u2013 but these only take effect in the next <strong>priced round<\/strong>, when the startup raises capital at a specific valuation.<\/p>\n<p>Also, unlike with <a href=\"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/venture-debt\/\" target=\"_blank\" rel=\"noopener\">venture debt<\/a>, no warrants are initially issued to the SAFE investors, and no cash interest rate or ongoing fees are attached.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_2_SAFE_Note_Conversions_in_a_Series_A_Round_Valuation_Caps_and_Conversion_Discounts\"><\/span><strong>Part 2: SAFE Note Conversions in a Series A Round (Valuation Caps and Conversion Discounts)<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>We\u2019ll assume here that this startup plans to raise <strong>$5 million at a $10 million pre-money valuation.<\/strong><\/p>\n<p>That means the post-money valuation is $5 + $10 = $15 million, so the VC firm expects to own ~33% of the company:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27187 size-full\" title=\"SAFE Notes in a Series A Round\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164034\/02-Series-A-Apparent-Ownership.jpg\" alt=\"SAFE Notes in a Series A Round\" width=\"1392\" height=\"152\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164034\/02-Series-A-Apparent-Ownership.jpg 1392w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164034\/02-Series-A-Apparent-Ownership-300x33.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164034\/02-Series-A-Apparent-Ownership-1024x112.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164034\/02-Series-A-Apparent-Ownership-768x84.jpg 768w\" sizes=\"(max-width: 1392px) 100vw, 1392px\" \/><\/p>\n<p>But this is not what happens in reality! <strong>The VC firm investing $5 million in this Series A will own less than 33% because of the shares that go to the SAFE Note investors<\/strong>.<\/p>\n<p>Here\u2019s the step-by-step process to calculate the ownership:<\/p>\n<h3><strong>Step 1: Calculate the \u201cPrice per Share\u201d in the Series A Round<\/strong><\/h3>\n<p>This is based on the pre-money valuation divided by the Pre-Money Share Count (the shares that existed <em>before<\/em> the Series A):<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27188 size-full\" title=\"Series A Price per Share Calculation\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share.jpg\" alt=\"Series A Price per Share Calculation\" width=\"1838\" height=\"612\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share.jpg 1838w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share-300x100.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share-1024x341.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share-768x256.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164036\/03-Series-A-Price-per-Share-1536x511.jpg 1536w\" sizes=\"(max-width: 1838px) 100vw, 1838px\" \/><\/p>\n<p>It\u2019s $7.50 here, which means the Series A investors pay $7.50 for each new share they purchase in this round.<\/p>\n<h3><strong>Step 2: Determine the \u201cPrice per Share\u201d for the SAFE Note Investors<\/strong><\/h3>\n<p>This is where the <strong>conversion discount<\/strong> and <strong>valuation cap<\/strong> come into play.<\/p>\n<p>If there\u2019s a <strong>conversion discount<\/strong>, the SAFE Note investors get their shares at a discount to the $7.50 the Series A investors pay:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27189 size-full\" title=\"Conversion Discount with SAFE Notes\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164039\/04-Conversion-Discount.jpg\" alt=\"Conversion Discount with SAFE Notes\" width=\"1422\" height=\"873\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164039\/04-Conversion-Discount.jpg 1422w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164039\/04-Conversion-Discount-300x184.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164039\/04-Conversion-Discount-1024x629.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164039\/04-Conversion-Discount-768x471.jpg 768w\" sizes=\"(max-width: 1422px) 100vw, 1422px\" \/><\/p>\n<p>If there\u2019s a <strong>valuation cap<\/strong>, the SAFE Note investors get their shares at a price equal to the Valuation Cap \/ Pre-Money Shares:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27190 size-full\" title=\"Valuation Cap for SAFE Notes\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap.jpg\" alt=\"Valuation Cap for SAFE Notes\" width=\"1572\" height=\"902\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap.jpg 1572w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap-300x172.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap-1024x588.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap-768x441.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/05-Valuation-Cap-1536x881.jpg 1536w\" sizes=\"(max-width: 1572px) 100vw, 1572px\" \/><\/p>\n<h3><strong>Step 3: Calculate Each Group\u2019s New Shares in this Priced Round<\/strong><\/h3>\n<p>The next step is to <strong>calculate the shares<\/strong> each group purchases or receives in this round based on the amounts they invested divided by their effective share prices:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27191 size-full\" title=\"SAFE Note Investors' Share Conversions\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/06-SAFE-Note-Share-Conversions.jpg\" alt=\"SAFE Note Investors' Share Conversions\" width=\"1423\" height=\"432\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/06-SAFE-Note-Share-Conversions.jpg 1423w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/06-SAFE-Note-Share-Conversions-300x91.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/06-SAFE-Note-Share-Conversions-1024x311.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164043\/06-SAFE-Note-Share-Conversions-768x233.jpg 768w\" sizes=\"(max-width: 1423px) 100vw, 1423px\" \/><\/p>\n<p>The <strong>valuations<\/strong> are based on the $7.50 overall share price in this round, times the number of shares each group has.<\/p>\n<h3><strong>Step 4: Link in the Post-Series A Cap Table and Calculate the Ownership Percentages<\/strong><\/h3>\n<p>Immediately after this Series A round, 1.33 million + 0.967 million shares = 2.3 million shares are outstanding.<\/p>\n<p>We <strong>assume<\/strong> that the 133,333 options owned by the employees stay the same.<\/p>\n<p>Based on this new total share count, we can calculate each group\u2019s ownership and share value:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27192 size-full\" title=\"Series A Cap Table After SAFE Note Conversions\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164047\/07-Series-A-Cap-Table.jpg\" alt=\"Series A Cap Table After SAFE Note Conversions\" width=\"1206\" height=\"528\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164047\/07-Series-A-Cap-Table.jpg 1206w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164047\/07-Series-A-Cap-Table-300x131.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164047\/07-Series-A-Cap-Table-1024x448.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164047\/07-Series-A-Cap-Table-768x336.jpg 768w\" sizes=\"(max-width: 1206px) 100vw, 1206px\" \/><\/p>\n<p>The Series A investors own <strong>less than 33%<\/strong> because the Seed Investors got their shares \u201cfor free\u201d in this round based on their previous investment.<\/p>\n<p>Therefore, the \u201ctrue\u201d Pre-Money Valuation was higher.<\/p>\n<p>If we recalculate it based on the $10 million plus the value of the shares granted to the SAFE Note investors in this round, we get the Series A investors\u2019 ownership:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27193 size-full\" title=\"Series A &quot;True&quot; Pre-Money Valuation and Ownership\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164048\/08-Series-A-True-Ownership.jpg\" alt=\"Series A &quot;True&quot; Pre-Money Valuation and Ownership\" width=\"1392\" height=\"250\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164048\/08-Series-A-True-Ownership.jpg 1392w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164048\/08-Series-A-True-Ownership-300x54.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164048\/08-Series-A-True-Ownership-1024x184.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164048\/08-Series-A-True-Ownership-768x138.jpg 768w\" sizes=\"(max-width: 1392px) 100vw, 1392px\" \/><\/p>\n<p>Because of this issue, people have developed different ways to determine the number of shares that SAFE Notes convert into.<\/p>\n<p>For example, they might use the \u201cDollars Invested\u201d method, a weighted average of the share prices, or another method to find a middle ground between the investor groups.<\/p>\n<p>However, since the exact method is not always spelled out in the investment term sheets, this point sometimes turns into a conflict or heated debate between the SAFE Note and Series A investors.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_3_How_an_Options_Pool_Complicates_SAFE_Notes_Even_More\"><\/span><strong>Part 3: How an Options Pool Complicates SAFE Notes Even More<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>We assumed in this simple example that the employee options remained the same at 133,333.<\/p>\n<p>But this <strong>options pool<\/strong> is usually <strong>upsized or re-sized<\/strong> in a priced round, such as a Series A, and that creates additional complications because now the employees effectively get \u201cfree shares.\u201d<\/p>\n<p>These free shares dilute the Series A and SAFE Note investors and reduce their ownership percentages.<\/p>\n<p>To calculate the impact, start with the <strong>total non-option shares<\/strong> after the SAFE Note conversions and Series A funding, which are 1.2 million + 966,667 = 2.167 million in this case.<\/p>\n<p>Then, divide this by <strong>(1 &#8211; Options Pool %)<\/strong>, where the &#8220;Options Pool %&#8221; is the percentage of company shares that employees should own in the form of options:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27194 size-full\" title=\"Effect of Options Pool on Post-Series A Ownership\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164049\/09-Series-A-Options-Pool.jpg\" alt=\"Effect of Options Pool on Post-Series A Ownership\" width=\"1162\" height=\"644\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164049\/09-Series-A-Options-Pool.jpg 1162w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164049\/09-Series-A-Options-Pool-300x166.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164049\/09-Series-A-Options-Pool-1024x568.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164049\/09-Series-A-Options-Pool-768x426.jpg 768w\" sizes=\"(max-width: 1162px) 100vw, 1162px\" \/><\/p>\n<p>The employees should have 20% * 2,708,333 = 541,667 shares after this round, and they already have 133,333 options.<\/p>\n<p>Therefore, they receive 541,667 \u2013 133,333 = 408,333 additional options in this round, which count as \u201cfree shares.\u201d<\/p>\n<p>This further dilutes the Series A investors down to <strong>~25% ownership:<\/strong><\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27195 size-full\" title=\"Series A Investor Dilution from Options Pool Upsizing\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164051\/10-Series-A-Dilution-from-Options-Pool.jpg\" alt=\"Series A Investor Dilution from Options Pool Upsizing\" width=\"965\" height=\"588\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164051\/10-Series-A-Dilution-from-Options-Pool.jpg 965w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164051\/10-Series-A-Dilution-from-Options-Pool-300x183.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164051\/10-Series-A-Dilution-from-Options-Pool-768x468.jpg 768w\" sizes=\"(max-width: 965px) 100vw, 965px\" \/><\/p>\n<p>This may not seem like a big deal, but if this startup sells for $100 million, it will mean the difference between the Series A investors getting $33 million vs. $25 million.<\/p>\n<p>$33 million in proceeds is a 6.6x multiple of the initial $5 million investment, while $25 million is a 5x multiple \u2013 and this difference is significant for early-stage venture capital firms.<\/p>\n<p><strong>The bottom line is that these SAFE Note conversions, the employee options pool, and anything else that creates \u201cfree shares\u201d significantly impact VC investors in any startup deal<\/strong>.<\/p>\n<p>That\u2019s why startups cannot afford to ignore these points and must be precise with their investment term sheets&#8217; language and conversion methods.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Part_4_Are_SAFE_Notes_Worth_It\"><\/span><strong>Part 4: Are SAFE Notes Worth It?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>When SAFE Notes were introduced in 2013, they had <strong>substantial advantages<\/strong> over \u201cpriced equity.\u201d<\/p>\n<p>Back then, priced rounds were much more expensive, requiring higher legal fees and more negotiation time.<\/p>\n<p>But in the past 10+ years, <strong>the advantages of SAFE Notes have diminished<\/strong>.<\/p>\n<p>Priced rounds have become cheaper and easier due to widely used templates and packaged services from law firms, and the disadvantages of SAFE Notes have become clearer.<\/p>\n<p>For example:<\/p>\n<ul>\n<li>SAFE Notes create <strong>messy cap tables<\/strong> and unclear ownership following a priced round because different investors sometimes disagree about the conversion methods.<\/li>\n<li>If the Notes use a <strong>valuation cap<\/strong>, they effectively set a price because few VCs will want to exceed that cap in the next round. So, the startup founders may not necessarily be able to \u201cavoid or defer\u201d the valuation discussion.<\/li>\n<li>If the startup fails, SAFE Note investors are in an <strong>awkward position<\/strong> because the notes are neither debt nor equity, so the exact treatment in a bankruptcy or liquidation is not always clear.<\/li>\n<\/ul>\n<p>We believe Y Combinator and other startup incubators pushed SAFE Notes and similar instruments heavily <strong>because they knew most startups would fail before ever reaching their Series A rounds.<\/strong><\/p>\n<p>If that happens, SAFE Notes don\u2019t cause any ownership issues in these next priced rounds.<\/p>\n<p>So, startups <strong>retain the advantages<\/strong> and avoid dealing with the negative consequences later.<\/p>\n<p>The startup incubator logic was simple: Get quick and cheap funding for as many companies as possible, wait for the survivors to rise to the top, and let the successful companies deal with ownership and dilution issues later.<\/p>\n<p>This logic isn\u2019t necessarily \u201cwrong\u201d but is quite a <strong>cynical<\/strong> way to approach startup investing and advisory.<\/p>\n<p>After <a href=\"https:\/\/www.ycombinator.com\/blog\/announcing-the-safe-a-replacement-for-convertible-notes\/\" target=\"_blank\" rel=\"noopener\">Paul Graham of Y Combinator enthusiastically introduced SAFE Notes in 2013<\/a>, he faced some <a href=\"https:\/\/avc.com\/2019\/05\/unsafe-notes\/\" target=\"_blank\" rel=\"noopener\">pushback from other well-known VCs and startup investors, such as Fred Wilson<\/a>:<\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27196 size-full\" title=\"Paul Graham - SAFE Note Introduction in 2013\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164100\/11-Paul-Graham-SAFE-Notes.jpg\" alt=\"Paul Graham - SAFE Note Introduction in 2013\" width=\"742\" height=\"810\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164100\/11-Paul-Graham-SAFE-Notes.jpg 742w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164100\/11-Paul-Graham-SAFE-Notes-275x300.jpg 275w\" sizes=\"(max-width: 742px) 100vw, 742px\" \/><\/p>\n<p><img decoding=\"async\" class=\"alignnone wp-image-27197 size-full\" title=\"Fred Wilson - Criticism of SAFE Notes\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164055\/12-Fred-Wilson-SAFE-Notes.jpg\" alt=\"Fred Wilson - Criticism of SAFE Notes\" width=\"710\" height=\"820\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164055\/12-Fred-Wilson-SAFE-Notes.jpg 710w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/01\/03164055\/12-Fred-Wilson-SAFE-Notes-260x300.jpg 260w\" sizes=\"(max-width: 710px) 100vw, 710px\" \/><\/p>\n<p>Based on everything here, we\u2019d give the <strong>victory to Fred Wilson<\/strong>.<\/p>\n<p>SAFE Notes are a textbook example of making something \u201cfaster and cheaper\u201d in the short term while creating potential long-term problems.<\/p>\n<p>And if you\u2019re operating a startup, you should usually focus on traditional priced equity rounds.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this tutorial, you&#8217;ll learn about &#8220;SAFE Notes&#8221; for investing in startups, how they compare to traditional priced equity rounds, and whether they&#8217;re actually &#8220;unsafe&#8221; for startups.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-27185","biws_kb","type-biws_kb","status-publish","hentry","kb_category-venture-capital"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/27185","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=27185"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}