Understanding the ownership structure of a company is crucial for founders. Convertible instruments make it difficult for founders to determine their ownership stake. Founders should understand their capitalization table and use tools like captable.io and Carter. SAFEs (Simple Agreement for Future Equity) simplify negotiations by focusing on the amount invested and valuation cap. Post-money SAFEs calculate the post-money valuation by adding the pre-money valuation to the amount raised. Dilution is the process of decreasing ownership percentage when founders sell a portion of their company. Priced rounds involve determining pre-money valuation, total raise, and post-money valuation. Consult with lawyers and advisors during priced rounds. The most profound aspect is understanding the calculations involved in converting SAFEs into company shares and determining dilution. Convertible notes and SAFEs are fundraising instruments. Use SAFEs for future fundraising and keep track of dilution. Avoid over-optimizing for valuation caps.
Introduction
Understanding the ownership structure of a company is crucial for founders at all stages of its life cycle. Founders need to be aware of how much of their company they have sold to investors and how much they still own. Many companies raise money through convertible instruments, making it difficult for founders to determine their ownership stake. Founders should take responsibility for understanding their capitalization table (cap table) and use tools like captable.io and Carter to keep track of ownership. The video also discusses SAFEs and priced equity rounds, explaining how they work and the importance of dilution. The speaker provides top tips on raising money.
SAFEs
A SAFE (Simple Agreement for Future Equity) is an investment instrument used by early-stage startups. It simplifies negotiations by focusing on the amount invested and valuation cap. SAFEs do not have interest rates or maturity dates. The conversion process is similar to convertible debt. Key details include the investment amount and valuation cap. SAFEs are typically five pages long and address events like equity financing rounds and liquidation. They clarify liquidation priority and provide definitions for terms used. Understanding sections one and two is crucial.
Post-money SAFEs
Post-money SAFEs are a type of investment agreement introduced by Y Combinator to simplify founders' understanding of dilution when raising funds. The post-money valuation is calculated by adding the pre-money valuation to the amount raised, determining investors' ownership. There are three types of post-money SAFEs: discounted, uncapped, and uncapped with a most favored nation clause. The most common type is the valuation cap.
Dilution
Dilution is the process of decreasing ownership percentage when founders sell a portion of their company to investors. It is important to consider dilution when raising money, as selling too much of the company can lead to future dilution. In the context of SAFEs and priced equity rounds, dilution can significantly impact the ownership percentage of the founders. The inclusion of an option pool and the issuance of shares can also change the cap table of a company.
Priced rounds
Priced rounds in startup funding involve determining pre-money valuation, agreeing on total raise, and calculating post-money valuation. Negotiating option pool increase is also important, typically around 10% to 15%. Lead investor in series A round expected to own around 20% of company. In a priced round, post-money SAFEs convert into shares, options pool increases, and new investors invest simultaneously. Price per share calculation includes shares from SAFEs conversion. Consult with lawyers and advisors during priced round.
Priced round dilution math
The most profound aspect of the topic of priced round dilution math is understanding the calculations involved in converting SAFEs into company shares and determining the dilution for investors, founders, and employees.
Key points:
- Converting SAFEs into company shares involves determining the total number of shares and allocating percentages based on the valuation cap in the SAFE.
- The conversion is based on the price round if the valuation is higher than the cap, and connected to existing shareholders.
- If the price round is lower than the cap, SAFE investors get a better deal, but negotiating high caps on SAFEs may result in selling more of the company than expected.
- The same calculation applies to convertible debt, and raising too much money on low valuation caps may result in significant dilution in priced rounds.
- The ownership percentages of different stakeholders in a company change after a priced equity round, with dilution occurring for existing shareholders.
- Understanding dilution and keeping track of ownership percentages is important, as there is limited control over dilution once money has been raised.
Top tips
Convertible notes and SAFEs are fundraising instruments. It is recommended to use SAFEs instead of a combination of SAFEs and convertible notes to simplify calculations. Post-money SAFEs are now recommended to track future dilution. Companies should switch to post-money SAFEs even if they have previously used pre-money SAFEs.
Don't over-optimize
Don't over-optimize when raising money on SAFEs. Focus on using the money to make the company successful rather than getting caught up in unnecessary negotiations. Key points:
- Over-optimizing for the cap can be counterproductive
- Competing on higher valuations is not always beneficial
- Negotiating with experienced investors can be challenging
- The difference in ownership between different caps is not significant, especially with multiple founders.
Conclusion
- Use SAFEs for future fundraising
- Keep track of dilution
- Understand where the company is being sold
- Avoid over-optimizing for valuation caps