The conversion discount . Safe Price: Price Per Share = Valuation Cap/Company Capitalization Standard Preferred Stock : The preferred stock that will be issued at the next equity financing. To help a growing number of YC companies based outside of the U.S. (50% of the W21 batch), YC revised the most commonly used "Valuation Cap, no Discount" post-money safe and optional side letter for companies formed in Canada, the Caymans and Singapore in March 2021. The valuation caps are the only negotiable detail. Looking again at the first row as an example, we first apply the 20% discount to the proposed pre-money valuation of $2,000,000, giving us a discounted valuation of $1,600,000. change of control) or dissolution of the company and the parties can also negotiate a CAP on the valuation used in connection with the SAFE, and this . But because of the 20% discount, the cap doesn't come into play until the discounted amount exceeds the cap. This process protects investors against dilution should the starting valuation of the company increase significantly between funding. This convertible note was created by 500 Startups as an alternative to the SAFE and standard convertible note. "Converting Securities" includes this Safe and other convertible securities issued by the Company, including A valuation ca p is a more variable kind of discount. For example, if an investor's SAFE has a valuation cap of $1 million, and the company's valuation at the next funding round reaches $2 million, the SAFE will nevertheless convert into equity at the valuation cap price of $1 million. Y Combinator's pre-money SAFE (Simple Agreement for Future Equity) was born in 2013, offering an even simpler and cheaper alternative to funding other than by way of a priced equity round, and in 2018, Y Combinator released its post-money SAFE. An investor will get stock at a later date in exchange for the cash investment now. Next, we apply the discount to the new investment valuation, which in this case is $5,000,000 * (1-.2) = $4,000,000. You raise $500,000 in convertible debt or equity with a valuation cap of $3M and a 15% discount. Safe: Valuation Cap, No Discount (Canada) So we use the Conversion Cap valuation of $4M to convert. Valuation Cap Valuation Cap. The glossary is built so you can follow along — each term is listed in the order it appears in Y Combinator's Safe: Cap and Discount term sheet. If a SAFE has a valuation cap and a conversion discount, the investor typically gets to take advantage of whichever option gets them a lower price per share. During the conversion, the investor can take advantage of either of them, whichever is more favorable. The Convertible Note and SAFE Note lets you take funding without going through the valuation process. The Valuation Cap is an upper limit on the price per share a SAFE investor will pay for Series A stock. The Double-Edged Sword of the Valuation Cap. SAFE stands for "simple agreement for future equity" and it is still most popular in California. SAFE notes. YC uses this example: if a company is raising $2 million at a $10 million pre-money valuation, generally that's the same as saying that it is raising $2 million at . The KISS might or might not have a maturity date or interest rate. SAFE notes don't require filling with the . Valuation Cap: The maximum valuation investors will convert their investment into equity in the next round. Based on the SAFE investment of $500,000, that means the SAFE investor holds 31.25% of the shares, prior to the equity investment ($500,000/$1,600,000). In this example, that means the future valuation must exceed $5M before the cap comes into play. if, at the series a, the startup raises money from a venture capital firm that invests at a pre-money valuation of $10m with a per share price of $5.00 if we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) if we apply the cap, the price per share would be $2.50/share ($5.00 times ($5m cap divided by $10m … If the SAFE has both a discount and cap, Investor will be issued Series A-1 preferred shares ("SAFE Preferred Stock") at either the Discount Price or the SAFE Price (i.e., Valuation Cap price) below, whichever results in greater # of shares. The discount for the convertible note or SAFE is calculated by dividing the valuation cap by the traditional equity financing valuation and then subtracting that value from 1 (representing no discount). Here's a formula to determine if the discount or valuation cap is better: $ X = V a l u a t i o n C a p / D i s c o u n t R a t e Where Discount Rate = 100% - discount. You have set aside 300,000 shares in your equity incentive plan. That's NOT how this works." Before using any of these forms, you should consult with a lawyer licensed in the relevant country. FINALLY When valuation cap is a better deal: if the company was raising their next financing round at a $20 million valuation and converting the SAFEs, then your SAFE would either convert at a 20% discount ($20M*.8 = $16M), or a . For example, if your business raises a venture round at a $10 million pre-financing valuation but your notes have a $3 million cap, your note holders just got a 70% discount (yep, you read that right). However, like convertible notes, some SAFEs will have a valuation cap or a maximum valuation at which the amount will convert. Most companies include a valuation cap and a discount. Let's get the conclusion out there and go through the "why" next. The TEN Capital Convertible Note Calculator provides the amount of equity a convertible note takes upon conversion. If the valuation cap is a regular valuation cap, then the fully-diluted capitalization used for the safe conversion will be 10 million shares. Initially made available by Y Combinator (YC) in 2013 and subsequently updated in late 2018, the SAFE investment instrument was intended to improve on the highly popular convertible note used by startups during the seed stage or as a short-term bridge between equity funding rounds. A higher number is better for the company (generally). The Valuation Cap results in a price per share of $0.72727. It's defined in terms of the company's market cap rather than share price. the Conversion Cap: $4M. A discount rate in a SAFE Note entitles the investor to purchase shares at a discounted price. The Discount Rate does not apply in this case. This is because the $1 million is 5% of $20 million, and 5% of 10,526,316 is 526,316. In our first scenario . Suppose the following key facts: You and your Co-Founders own 2M shares in the aggregate. The discount price generally refers to the price per share of the equity or liquidation event multiplied by the discount rate. The biggest difference between a SAFE and a convertible note is that a SAFE is not debt. I let out a big groan. Y Combinator. It is incredibly important to know that the SAFE defines a "Discount Rate", not a discount. For a more complete description of the valuation cap . A discount reduces the price per share for the SAFE note holder when the company actually starts selling stock. Feel free to download the Safe Spreadsheet here: SafeSpreadsheetExamples. e.g., 100% - 20% = 80%. Notes are issued i. Pascal Levensohn, Andrew Krowne. Accordingly, the company will issue 137,500 . The valuation cap on this SAFE is $10 million. You offer a note or SAFE with a 15-20% discount. the Conversion Discount applied to the Pre-Money Valuation: 15% off of $5M = $4.25M. Valuation caps and conversion discounts are mechanisms by which convertible debtholders can convert their debt positions into preferred equity at a lower company valuation than the latest funding round. SAFE contains provisions for early exit (e.g. The cap is $100m post money. Suppose XYZ LTD raised $50,000 from Mr C by issuing a SAFE with a $5M valuation cap and 40% discount. SAFE's provide the company with an obligation to deliver a variable number of shares based on a future unknown priced round (discounted) or a valuation cap. For example, let's say you invest in a company offering a Crowd SAFE with a 20% discount and a $10 million valuation cap. Valuation cap. So, for example, if your seed investors invest in a convertible note with a $10 million valuation cap, this "super MFN" provision will amend the F&F SAFEs to provide an $8 . This determines the highest price that can be used to set the conversion price. With a valuation cap, they know that their money will convert from loan to equity at or below a certain dollar . the conversion discount and valuation cap. If, for example, Series A investors pay $1 per share during a priced round, a SAFE holder with a conversion discount will get to purchase their shares at a rate below $1 per share. . The deal terms are a convertible note or a SAFE with a 20% discount and no valuation cap. To compensate for this, founders often offer early investors discounts in addition to caps. A discount rate in a SAFE Note entitles the investor to purchase shares at a discounted price. For example, if the company offered SAFE note holders a 20% discount and achieves a valuation of $10 million, with shares available to new investors at $10, the SAFE investors will be able to buy their shares at $8, thus receiving a 20% discount. I will not invest in an uncapped note or SAFE. If the SAFE had a valuation cap of $1 million, the SAFE holder would receive shares valued at $0 . 1.3 "Note Conversion Price" means [the lower of]: (a) the lowest per share purchase price paid for the Qualified Financing Securities by the investors of new money in the Qualified Financing, multiplied by [DISCOUNT RATE] [; or (b) the quotient obtained by dividing (1) the Valuation Cap (as defined below) by (2) the Company's fully-diluted capitalization immediately prior to the initial . $1 million investment / $10 million valuation cap = 10% Because it's a post-money SAFE, the investor has effectively "locked in" a 10 percent ownership in your company. As of March 2021, we're unveiling beta versions of the "Valuation Cap, no Discount" post-money safe and optional side letter for companies formed in Canada, the Caymans and Singapore. Key terms: Your input variables are: the amount you're raising on the convertible note (say $500k), the conversion discount of the note (say 20%), the pre-money valuation cap of the note (say $4m), the percentage of your company which the VCs will take in your Series A (say 30%), the amount of money you expect to raise in your Series A (say somewhere . Example 2: a VC invests $2.5M on a pre-money valuation of $4M. Live. For example, an investor buys a note with a 20% discount and a cap of $5M. I sure hope these uncapped deals I'm being pitched recently are a coincidence and not a trend. The Valuation Cap results in a price per share of $0.72727. Customizations may also include additional protections for major investors, such as rights of first offer (ROFO), observer rights, information rights and other rights. Thus, this is a convertible note where the price is exactly $10M regardless of next round . It contains YC's latest safe version, post-money safe v1.1. The cap value never changes. The math on this calculation is as follows: ($100,000 principal + $4,000 of interest)/ (80% x $1.60) = 81,250 shares. A quick calculation learns that in this example a valuation of EUR 2,500,000 is the turning point, because: EUR 2,000,000 (cap) / 0,8 (discount) = EUR 2,500,000. The discount is used if the SAFE investor money converts in future financing rounds and the valuation was at or below the valuation cap. The 9 Y-Combinator examples and scenario parameters are summarized below: Example 1, Equity Financing, Safe Valuation Cap, No discount = In this case the equity financing pre-money exceeds the Safe valuation cap. Generally speaking, the discount is only applied if the valuation is below the agreed-upon cap. A convertible note is a debt instrument that converts to equity later. Fill out details like your bank wire instructions so you can share your SAFE as soon as you're ready to go. Answer: A valuation cap applies to convertible notes and SAFEs. In cases when both the valuation cap and the discount clause is included in SAFE, the investor weighs both the options at the time of valuation and converts his SAFE at the lowest possible rate. Discounts are fixed—typically at 20% or less. Next, we apply the discount to the new investment valuation, which in this case is $5,000,000 * (1-.2) = $4,000,000. Discount SAFE agreements can include a discount. In contrast to the convertible note, as the name implies, the SAFE was simpler (in both features and typical length), and was completely standardized, thereby reducing transaction costs for very early stage companies. More often than not though, convertible notes have both a valuation cap and discount and will convert using whichever method gives the investor a lower price per share: Combining our previous examples, let's say an issuer raises its seed round by issuing a convertible note with a $4M valuation cap and a 20% discount. 11:00 AM PDT • July 8, 2017. "1) Here's a common trap: Let's say a company is raising on a SAFE. In this way, the SAFE investor shares in the upside of the company between the time the SAFE is signed (and funding provided) and the trigger event. If the Crowd SAFE includes both a valuation cap and a discount, the provision more favorable to the investor applies if there is ever a trigger event. In the first example above where the discount was 20%, the cap was $5 million and the pre-money valuation was $10 million, we saw that the conversion price was (i) $.80 when we applied the . simple agreement for future equity. The shortcomings of . 0:00 / 3:00 •. But it does have a discount rate, a valuation cap, and a QFE of one million dollars. A valuation cap is used in a convertible note to give the noteholders a "ceiling" value at which their investment will convert and, in turn, that gives them a "floor" in regard to their ownership. This determines the highest price that can be used to set the conversion price. From an investor's perspective, higher valuations reflect more expensive investments since investors must pay more for the same level of ownership. Discount and Valuation Caps: SAFE notes can include a discount that is applied to a future valuation when it is time to convert. Get a safe note template and fill out the concrete parts: Y Combinator offers a few formats. Seed Equity -> Series A: Please consider offering a reasonable valuation cap. Y Combinator introduced the safe (simple agreement for future equity) in late 2013, and since then, it has been used by almost all YC startups and countless non-YC startups as the main instrument for early-stage fundraising. Without a valuation cap or a discount price, the SAFE Note simply converts into equity at the price . After we run through the deal math, this is what the cap table looks like: The conversion price for the Note/SAFE is calculated by $6MM (valuation cap) / (5MM Common Stock + 1,530,476 Pool) = $0.92. The Investors in the Convertible Debt round get 100,000 * ($500k / $4M) = 12,500 shares. Cap and discount in a Note or SAFE are discreet alternatives to one another. Valuation Cap - More commonly known as cap, it's the maximum valuation that the investor will be valued at if the SAFE already converts to equity. Seed Equity -> Series A: This is a pretty confusing topic, so I think it's worth clarifying. The discount is a discount for the SAFE Cap and Discount investor on the price that a series-a investor pays. After we run through the deal math, this is what the cap table looks like: The conversion price for the Note/SAFE is calculated by $6MM (valuation cap) / (5MM Common Stock + 1,530,476 Pool) = $0.92. You then raise a Series Seed of $5M at a $12M pre-money . If the series-a investors pay $1.00 per share and there is a 20% discount, then the SAFE investors convert at $0.80 a share. The Safe converts into Safe Preferred A-1 Stock at a price . The less charitable view is that the elimination of the discount in Notes/SAFEs is a cynical power grab, pure and simple. The valuation cap specifies the maximum valuation at which the investment converts into equity or shadow shares. The valuation cap is usually between $2,000,000 - $10,000,000. Note that this means for a Continue Reading Related Answer Gil Silberman , I've founded more startups than I can remember, and advised hundreds. Here's a quick, skimmable glossary of terms to understand in a safe term sheet. However, it's pretty tricky to do in this environment with either instrument, so there is no clear winner for seed investment in this category. Commonly, I hear founders say, investors will convert at $90m (= 90% * $100m) post-money valuation. A convertible note is a security that is a hybrid of both debt and equity. Issue $20k for 6.06% equity. This illustration highlights why many investors pursue both caps and discounts. In this example such would be portrayed mathematically as $2 million / $4 million = 0.5 and 1 - 0.5 = 0.5. •. Accordingly, the company will issue 137,500 shares of Series A-1 Preferred to the safe holder, at $0.72727 per share. Using a SAFE means, technically, you can delay valuing your company. The company later raises with a $10M valuation—the investor's shares would convert at a $5M valuation. In this case, during your first funding round, your Series A documents will include three subseries: Series A1, Series A2, and Series A3. The biggest change in the notes is that the cap is now "post-money", which refers to the valuation "post" all the SAFE rounds and immediately after the investment is made. A valuation cap is something that applies to convertible notes. The SAFE is not a debt instrument - it has no repayment date - and is not strictly an equity . Many startups are initially seed-funded, meaning that they initially receive . By using the valuation cap the number of shares the Early Investor will receive is: EUR 100.000 / EUR 200 = 500 shares. Why SAFE notes are not safe for entrepreneurs. This is PLAIN WRONG. Now let's compare the Post-close Series A cap table between the Seed Equity v. the Seed Note/SAFE scenarios. Unlike a convertible note, a SAFE is not a loan . Because a safe has no . In order to determine the valuation that will be applied to the SAFE note investment, we need to determine whether the cap or the discount will be used (it is not standard practice to use both). A SAFE is a capital raising instrument under which an amount invested by an investor will convert into .

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