Notes are issued i. For example, let's say you invest in a company offering a Crowd SAFE with a 20% discount and a $10 million valuation cap. 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. It then converts into equity in that company at a trigger event. 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. 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. Depending on your negotiating skills and your company's traction, you can get a SAFE or convertible note without a valuation cap. It is incredibly important to know that the SAFE defines a "Discount Rate", not a discount. Cap and discount in a Note or SAFE are discreet alternatives to one another. It can also have a valuation cap that sets the highest price that can be used to set the conversion rate. 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. But because of the 20% discount, the cap doesn't come into play until the discounted amount exceeds the cap. Next, we apply the discount to the new investment valuation, which in this case is $5,000,000 * (1-.2) = $4,000,000. FINALLY This process protects investors against dilution should the starting valuation of the company increase significantly between funding. And the discount rate is 90%. Discount - This refers to the discount that the venture capital firm, angel, or startup could get at the next financing round's valuation. 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. "Today's tweet storm is about how the valuation cap and the discount work on a SAFE. The Double-Edged Sword of the Valuation Cap. 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. The 15% discount applied to the per share price of the Series A Preferred is $0.77265. I just wasted an hour. The cap is $100m post money. The Valuation Cap is an upper limit on the price per share a SAFE investor will pay for Series A stock. Many entrepreneurs think that a $4M cap means that any negotiated pre-money valuation higher than $4M results in the cap coming into play. 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. 0:00 / 3:00 •. The discount is a discount for the SAFE Cap and Discount investor on the price that a series-a investor pays. The deal terms are a convertible note or a SAFE with a 20% discount and no valuation cap. The Safe converts into Safe Preferred A-1 Stock at a price . I will not invest in an uncapped note or SAFE. 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 raise $500,000 in convertible debt or equity with a valuation cap of $3M and a 15% discount. If the valuation cap is a regular valuation cap, then the fully-diluted capitalization used for the safe conversion will be 10 million shares. Example: SAFE with both valuation cap and discount. In this example such would be portrayed mathematically as $2 million / $4 million = 0.5 and 1 - 0.5 = 0.5. 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. . Issue $20k for 6.06% equity. The Investors in the Convertible Debt round get 100,000 * ($500k / $4M) = 12,500 shares. A valuation cap is something that applies to convertible notes. A safe is a Simple Agreement for Future Equity. A SAFE is a capital raising instrument under which an amount invested by an investor will convert into . One of the most important features of a SAFE Note is a valuation cap. 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. . The valuation cap on this SAFE is $10 million. You then raise a Series Seed of $5M at a $12M pre-money . SAFE notes don't require filling with the . "1) Here's a common trap: Let's say a company is raising on a SAFE. I let out a big groan. Unlike a convertible note, a SAFE is not a loan . This is a pretty confusing topic, so I think it's worth clarifying. A valuation cap is pre-money : the 'cap' or limit is placed on the starting valuation of the company before the financing round. This would generally lead you to Accounting Standards Codification ("ASC") 480-10-14 which talks about a . The biggest difference between a SAFE and a convertible note is that a SAFE is not debt. 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). Startups and investors will usually only have to negotiate one item: the valuation cap. 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. KISS: Keep It Simple Security, or KISS, is similar to a SAFE. Y Combinator. SAFE contains provisions for early exit (e.g. Valuation Cap. A discount rate in a SAFE Note entitles the investor to purchase shares at a discounted price. Without a valuation cap or a discount price, the SAFE Note simply converts into equity at the price . Because a safe has no . Feel free to download the Safe Spreadsheet here: SafeSpreadsheetExamples. This tool provides a template for a Simple Agreement for Future Equity (SAFE) with a valuation cap and no discount rate, also known as a "Standard SAFE" and can be adapted to suit your organization's needs. Accordingly, the company will issue 137,500 shares of Series A-1 Preferred to the safe holder, at $0.72727 per share. For a more complete description of the valuation cap . The shortcomings of . The conversion discount . In this case, during your first funding round, your Series A documents will include three subseries: Series A1, Series A2, and Series A3. Safe: Valuation Cap, No Discount (Canada) 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. $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. The less charitable view is that the elimination of the discount in Notes/SAFEs is a cynical power grab, pure and simple. 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 valuation caps are the only negotiable detail. with valuation cap, no discount, 2) no valuation cap, with discount, 3) valuation cap and discount, 4) no valuation cap, no . Valuation Cap: The maximum valuation investors will convert their investment into equity in the next round. 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 . . The conversion valuation cap (or "cap") is a different mechanism that can be used to reward early investors for the risk they take and hopefully efforts they make to help increase the value of the startup. These conditions generally involve a valuation cap for the company and/or a discount to the share valuation at the moment of the trigger event. 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). . 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). 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. Thus, this is a convertible note where the price is exactly $10M regardless of next round . The discount price generally refers to the price per share of the equity or liquidation event multiplied by the discount rate. 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. Discount SAFE agreements can include a discount. We've taken a conventional SAFE, and added an extra concept to ensure that an MFN provision gives your F&F a discount on the valuation cap that your seed investors get. the Conversion Cap: $4M. 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. The cap value never changes. This is PLAIN WRONG. For example, an investor buys a note with a 20% discount and a cap of $5M. Accordingly, the company will issue 137,500 . To compensate for this, founders often offer early investors discounts in addition to caps. 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 is because the $1 million is 5% of $20 million, and 5% of 10,526,316 is 526,316. Using a SAFE means, technically, you can delay valuing your company. Everyone is excited, they haven't done a lot of angel investing before, don't . Valuation Cap A discount reduces the price per share for the SAFE note holder when the company actually starts selling stock. "Conversion Price " means the either: (1) the Safe Price or (2) the Discount Price, whichever calculation results in a greater number of shares of Safe Preferred Stock. 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. Outside of Y Combinator, the SAFE is being scrutinized and utilized by startups in the . The KISS might or might not have a maturity date or interest rate. With a valuation cap, they know that their money will convert from loan to equity at or below a certain dollar . Note that this means for a Continue Reading Related Answer Gil Silberman , I've founded more startups than I can remember, and advised hundreds. •. Valuation cap, no discount; Discount, no Valuation cap; MFN, no valuation cap, no discount; Valuation cap and discount A convertible note is a debt instrument that converts to equity later. The Convertible Note and SAFE Note lets you take funding without going through the valuation process. 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 company later raises with a $10M valuation—the investor's shares would convert at a $5M valuation. In this example, the Early investor will choose for the cap. Example 2: a VC invests $2.5M on a pre-money valuation of $4M. Answer: A valuation cap applies to convertible notes and SAFEs. 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. Get a safe note template and fill out the concrete parts: Y Combinator offers a few formats. That's NOT how this works." How Does the Calculator Work? Before using any of these forms, you should consult with a lawyer licensed in the relevant country. Here's a quick, skimmable glossary of terms to understand in a safe term sheet. the conversion discount and valuation cap. 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). 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 . Customizations may also include additional protections for major investors, such as rights of first offer (ROFO), observer rights, information rights and other rights. 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 . (in this particular SAFE the cap of $10M is the conversion price and even if the future equity round happens at a valuation less than $10M, the note will still convert at $10M. An investor makes a cash investment in a company, but gets company stock at a later date . the Conversion Discount applied to the Pre-Money Valuation: 15% off of $5M = $4.25M. 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 . SAFE notes. 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. The valuation cap specifies the maximum valuation at which the investment converts into equity or shadow shares. 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). SAFE notes offer this advantage to investors through discounts, valuation caps, or both. It's defined in terms of the company's market cap rather than share price. Live. Suppose XYZ LTD raised $50,000 from Mr C by issuing a SAFE with a $5M valuation cap and 40% discount. More here >>" A valuation ca p is a more variable kind of discount. SAFE stands for "simple agreement for future equity" and it is still most popular in California. This illustration highlights why many investors pursue both caps and discounts. A convertible note is a capital raising instrument that acts as a debt in the form of a loan made to the company. SAFEs are short five-page documents. Pascal Levensohn, Andrew Krowne. An investor will get stock at a later date in exchange for the cash investment now. e.g., 100% - 20% = 80%. 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. Let's get the conclusion out there and go through the "why" next. Seed Equity -> Series A: Please consider offering a reasonable valuation cap. . How to Calculate SAFE Price per Share. Similar to a convertible note, the Safe can be tailored to include a valuation cap, a discount or both (or neither), allowing it to be easily customized for the investor. The Discount Rate does not apply in this case. So we use the Conversion Cap valuation of $4M to convert. In our first scenario . I sure hope these uncapped deals I'm being pitched recently are a coincidence and not a trend. 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. The math on this calculation is as follows: ($100,000 principal + $4,000 of interest)/ (80% x $1.60) = 81,250 shares. They were created in 2013 by Y Combinator, a Silicon Valley accelerator, and allow startups to structure seed investments without interest rates or maturity dates. Issue $100k on a YC-SAFE note at $10M price. Without a valuation cap or a discount price, the SAFE Note simply converts into equity at the price . The 15% discount applied to the per share price of the Series A Preferred is $0.77265. 3. Many startups are initially seed-funded, meaning that they initially receive . Suppose the following key facts: You and your Co-Founders own 2M shares in the aggregate. Now let's compare the Post-close Series A cap table between the Seed Equity v. the Seed Note/SAFE scenarios. If the convertible notes were issued with a 20 percent discount and no cap, then the convertible notes would have converted into 81,250 shares. Why SAFE notes are not safe for entrepreneurs. You offer a note or SAFE with a 15-20% discount. This determines the highest price that can be used to set the conversion price. The Valuation Cap results in a price per share of $0.72727. The TEN Capital Convertible Note Calculator provides the amount of equity a convertible note takes upon conversion. The valuation cap is usually between $2,000,000 - $10,000,000. SAFE (simple agreement for future equity) notes are a simpler alternative to convertible notes. "Converting Securities" includes this Safe and other convertible securities issued by the Company, including Most companies include a valuation cap and a discount. Discounts are fixed—typically at 20% or less. Source: Y Combinator SAFE Primer Valuation cap. The discount only applies when the cap value isn't reached. If the valuation cap is a post-money valuation cap, then it will be 10,526,316 shares. Generally speaking, the discount is only applied if the valuation is below the agreed-upon cap. From an investor's perspective, higher valuations reflect more expensive investments since investors must pay more for the same level of ownership. In this example, that means the future valuation must exceed $5M before the cap comes into play. Fill out details like your bank wire instructions so you can share your SAFE as soon as you're ready to go. This determines the highest price that can be used to set the conversion price. Discount and Valuation Caps: SAFE notes can include a discount that is applied to a future valuation when it is time to convert. 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. Key terms: Commonly, I hear founders say, investors will convert at $90m (= 90% * $100m) post-money valuation. 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. Next, we apply the discount to the new investment valuation, which in this case is $5,000,000 * (1-.2) = $4,000,000. 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. 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. The SAFE is something like a warrant entitling investors to shares in the company, typically preferred stock, if and when there is a future valuation event (i.e., if and when the company next raises "priced" equity capital, is acquired or files an IPO.) 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. 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 . 11:00 AM PDT • July 8, 2017. However, like convertible notes, some SAFEs will have a valuation cap or a maximum valuation at which the amount will convert. 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. A higher number is better for the company (generally). A discount rate in a SAFE Note entitles the investor to purchase shares at a discounted price. Seed Equity -> Series A: Now let's compare the Post-close Series A cap table between the Seed Equity v. the Seed Note/SAFE scenarios. You have set aside 300,000 shares in your equity incentive plan. During the conversion, the investor can take advantage of either of them, whichever is more favorable. Safe Price: Price Per Share = Valuation Cap/Company Capitalization Standard Preferred Stock : The preferred stock that will be issued at the next equity financing. A convertible note is a security that is a hybrid of both debt and equity. The valuation cap defines the maximum valuation at which a SAFE converts, effectively creating a floor for the SAFE holder's conversion. For example, a 20% discount rate means an investors money would buy shares at a $8m valuation if the priced round was $10m (20% 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. One of the most important features of a SAFE Note is a valuation cap. 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 … Https: //www.tamimi.com/law-update-articles/pre-money-vs-post-money-safes-the-key-differences-you-need-to-know/ '' > What is a valuation cap and no discount - Joyance Partners < /a > valuation. Generally lead you to Accounting Standards Codification ( & quot ; ASC & quot ; ) 480-10-14 which about! 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