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Understanding SAFEs and Priced Equity Rounds by Kirsty Nathoo

Y Combinator2018-10-17
YC#Y Combinator#Kirsty Nathoo#Startup School
291K views|5 years ago
💫 Short Summary

The video segments cover topics such as company ownership, cap tables, safes, convertible instruments, dilution, post-money safes, valuation caps, and fundraising rounds. It emphasizes the importance of understanding these concepts for startup funding decisions and discusses scenarios involving investors, founders, and employees. The segments provide insights into negotiation strategies, ownership calculations, and the implications of dilution on company ownership. The video highlights the significance of tracking dilution, using post-money safes, and avoiding unnecessary focus on valuation caps during fundraising rounds. Overall, it offers valuable advice for founders navigating the complexities of startup financing.

✨ Highlights
📊 Transcript
Importance of Understanding Company Ownership and Cap Table.
Founders must be aware of how much of the company is sold to investors and how much they own.
Many founders overlook the cap table, but it is crucial for CEOs to understand.
Maintaining a cap table can be done through simple spreadsheets or using tools like Cap Table.io and Carter.
It is essential to track shares and ownership from the beginning to avoid surprises later on.
Overview of safes and convertible instruments for raising money.
Safes involve investors providing funds in exchange for future equity, with negotiations focused on amount invested and valuation cap.
Safes are preferred by early-stage companies before transitioning to priced rounds with more complex terms.
Safes are not debt, distinguishing them from convertible debt instruments.
Overview of the anatomy of a safe.
Explains the difference between safe and convertible instruments, highlighting key negotiating points.
Discusses the five sections of a safe, covering scenarios like equity financing and liquidity events.
Addresses what occurs if the company is sold or closes while the safe is still outstanding.
Notable additions include clauses to ensure transparency in any changes to the safe.
Explanation of safe agreement sections, liquidation priority, and termination conditions.
Importance of sections one and two for understanding, with section three focusing on company representations.
Introduction of post-money safes as a new concept after all safes have converted.
Emphasis on the significance and rationale behind the introduction of post-money safes.
Explanation of pre-money and post-money valuations in fundraising rounds.
Post-money valuation is calculated by adding the amount raised to the pre-money valuation.
Investor ownership percentage is determined by their contribution divided by the post-money valuation.
Different types of safes with valuation caps, including discounts and uncapped safes, are explained.
Understanding these concepts is crucial for making startup funding decisions.
Types of Clauses in Investment Agreements
Uncapped safes with a most favored nation clause are explained, allowing for better terms with additional investors but increasing administrative burden for founders.
Dilution and cap tables are discussed in the context of incorporating a company with two founders splitting shares equally.
The importance of paperwork and vesting agreements in granting shares to founders is emphasized.
Implications of fundraising with post-money safe and dilution.
Founders sell 15% of the company and are diluted to 85%.
Future fundraising rounds will lead to further dilution for founders.
Only founders are currently being diluted, not earlier investors.
Structure of post-money safes dictates the dilution process.
Importance of having shares in the treasury to cover anticipated dilution.
Different post-money valuation caps explained, influenced by factors like risk and negotiation.
Companies raising funds to hire employees and creating an option pool for equity distribution.
Issuing shares to early employees can change the cap table, leading to more shareholders and fully diluted shares.
Founders' ownership percentage may decrease as a result of issuing shares.
Dilution of ownership is crucial to understand accurately.
Founders actually own 85% of the company after selling 15%.
Price round discussion involves a pre-money valuation of $15 million and a total raise of $5 million.
Lead investor will contribute $4 million, leading to a post-money valuation of $20 million.
Negotiations also include increasing the option pool for new employees by around 10-15%.
Key steps in a priced round after raising money through post-money SAFEs: conversion of SAFEs into shares, creation or increase of options pool, and new investor investment.
The order of these steps is crucial for accurate calculations during the fundraising process.
Including SAFEs in pre-money valuation discussions can lead to confusion.
Understanding the terminology and order of events is essential for founders and lawyers involved in fundraising.
Conversion of safes into company shares during a priced round.
Safes convert into 15% of the company, with investors receiving preferred shares with different rights than common shares.
Cap table provides information to calculate the total number of shares.
Algebra is used to determine shares allocated to safe investors, with the first investor receiving 5% and the second investor receiving 10%.
The cap table shown is just one step in the calculation process and may not reflect the final ownership distribution.
Discussion on post-money safes and their impact on employees and investors.
The percentage of 5-10% is determined by the valuation cap in the safe, which can change based on the priced round valuation.
In rare cases of a lower priced round, safe investors may benefit.
It is important not to negotiate safes too aggressively to avoid selling more of the company than intended.
Understanding the conversion triggers and implications for stakeholders is crucial.
Understanding convertible debt calculations and the impact on company ownership.
Raising too much money at low valuations can lead to significant dilution for existing shareholders.
Importance of comprehending dilution when transitioning to priced rounds is emphasized.
Relationship between cap and priced rounds is explained, showing scenarios where safeholders may receive more shares or a fair deal compared to series A investors.
It is crucial to avoid situations where the cap is higher than the priced round to ensure fair outcomes for investors.
Overview of Price Round Calculation Process
Shares are calculated using priced round price, potentially increasing based on delta.
Price rounds at lower valuations than safes are uncommon in the current environment.
Option pool is increased to 10% of post-money shares available.
Series A investors invest new money, determining price per share based on valuation divided by capitalization after safe conversion and option pool increase.
Determining the number of shares for Series A investors involves dividing their investment by the price per share.
Calculations include total shares issued, conversion of safes, and an increase to the option pool.
Lead investors receive a significant portion of new shares.
Safe investors experience a decrease in percentages due to dilution.
Founders' ownership increases to 51.5%, a significant jump from the original 92.5%.
Importance of tracking dilution in startup funding rounds.
Convertible notes and post-money safes are highlighted for tracking dilution in funding rounds.
Companies are advised to avoid combining safes and convertible notes for simplified calculations.
Post-money safes are recommended over pre-money safes for easier dilution understanding.
Caution against over-optimizing for cap valuation in funding rounds to prevent unnecessary competition and comparison among peers.
Importance of not over-optimizing valuation caps with investors.
Minor differences in ownership percentage for multiple co-founders make fixation on valuation caps unnecessary.
Focus should be on securing funding and building a successful company rather than minor valuation variations.
Post-money SAFEs are recommended for future fundraising efforts.
Understanding company dilution and valuation standing is crucial, with valuation caps not having as significant an impact as perceived.