The Post-Money Simple Agreement for Future Equity (or Post-Money SAFE) has become an essential tool for startups to quickly and cost-effectively raise capital. However, many lawyers and advisors tell founders to avoid using Post-Money SAFEs because they unfairly dilute the company’s founding team and employees in favor of investors. Can the benefits of Post-Money SAFEs overcome this cost?

How Does the Post-Money SAFE Unfairly Dilute Founders?

The difference between the Post-Money SAFE and the Pre-Money SAFE is how they treat conversion using the valuation cap. In general, a capped SAFE will convert into shares of preferred stock in an equity financing at a price per share equal to the quotient of the SAFE valuation cap divided by the company’s fully diluted capitalization. With a Pre-Money SAFE, the definition of the company’s fully diluted capitalization excludes all shares issuable upon conversion of all the company’s outstanding convertible securities. With a Post-Money SAFE, the definition of the company’s fully diluted capitalization includes all shares issuable upon conversion of all the company’s outstanding convertible securities.

This changed calculation means that other SAFEs and convertible securities will not dilute the Post-Money SAFE investor’s shares upon the Post-Money SAFE’s conversion. Instead, any additional SAFEs and convertible securities that the company issues will only dilute the founders and the company’s existing stockholders.

To illustrate, suppose I open a lemonade stand, and my parents give me $50 for 50% of my venture. I use the $50 to get the business started. Then, one of my customers is impressed with my lemonade and offers me $100 for a 10% stake in my lemonade stand.

Most people would agree that if I accept the investment, the resulting equity split should be 45% to my parents, 45% to me, and 10% to the customer-investor since I had used the $50 to build a company worth $1,000. In other words, the $50 should be considered “old” money and baked into the $1,000 valuation.

Suppose instead that my parents had invested $50 on a Post-Money SAFE with a $100 valuation cap, and the investor had invested $100 on a Post-Money SAFE with a $1000 valuation cap. Then, assuming conversion of the SAFEs and no new investments, the resulting equity split would be 50% to my parents, 10% to the customer-investor, and 40% to me. In this scenario, I would be the only one “unfairly” diluted by the outside investments.

Note: “Post-Money” SAFE is a somewhat confusing misnomer. The Post-Money SAFE is only “post-money” with respect to other SAFEs and convertible securities. After a Post-Money SAFE converts into shares in an equity financing, the as-converted shares still get diluted by new cash investments in the financing. This only compounds the dilution that the founders and existing stockholders experience.

Why Is the Post-Money SAFE Structured This Way?

In essence, the Post-Money SAFE aims to give all parties, particularly investors, upfront clarity of ownership. By contrast, investors in Pre-Money SAFEs have no clear picture of how much of a company they would own once their SAFEs convert. All other SAFEs and convertible securities dilute the Pre-Money SAFE, and there is generally no restriction on the amount that a startup can raise on SAFEs and convertibles.

This lack of ownership clarity became an appreciable issue as Pre-Money SAFE financing rounds started to supplant preferred stock financings in early-stage fundraising. Startups would often raise multiple large rounds of capital on Pre-Money SAFEs before raising a first preferred stock financing.

This development exposed at least two pain points, which Y Combinator sought to solve with its Post-Money SAFE revisions. First, it felt unfair to investors for their newer investments to get diluted by other investors’ older investments. Second, institutional investors need clarity of ownership to be able to write the larger checks in SAFE financings that used to be written only in preferred stock financings.

Should Startups Use the Post-Money SAFE?

Despite their drawbacks for founders and existing stockholders, Post-Money SAFEs have quickly become an essential fundraising tool in the startup ecosystem. As such, founders should familiarize themselves with Post-Money SAFEs and even embrace them in certain circumstances. 

At the time of this post, there is no other fundraising instrument as frictionless as the Post-Money SAFE. Post-Money SAFEs require minimal negotiation to close, bear no interest, and have no maturity date. These attributes allow founders to quickly raise capital and get back to what is most important--building a viable company.

With a little algebra, any founder can model the dilutive effect of issuing Post-Money SAFEs and plan for future dilution. With appropriate adjustments to round size and valuation caps, founders can use Post-Money SAFEs and still reach their desired ownership outcomes. And if the amount of money a company needs to raise doesn’t align with a valuation cap that the market will support, at least the dilutive effects of using the Post-Money SAFE will not be a surprise.

Preparation is key to getting the most out of Post-Money SAFEs. For prepared founders, Post-Money SAFEs are a practical and resource-efficient way to raise capital for early-stage startups.