#VCForFounders | SAFE

Notes — Part 2
Mario Ruiz

Welcome back! In the next part of the #VCForFounders

series, I will be finishing my review of SAFE note
agreements and provide detail on the mechanics of the
SAFE note during an Equity Financing and Liquidity Event.
I have included an illustrative example via Google Sheets
that can be found here.

You can find Part 1 of my post on SAFE notes here and

please stay tuned for next week’s post on convertible
notes!

If you enjoy reading this post or find it helpful, please

include a “clap” below. I would love to connect with
anyone interested in startups, entrepreneurship, or
venture capital. Connect with me at
https://www.linkedin.com/in/mariorruiz/

Note to reader: I am not a lawyer and the information

provided herein should not serve as a replacement for any
legal advice. Should you have any questions specific to
your startup, you should consult legal counsel.

For ease of understanding, I summarized and

paraphrased the definitions used in this post from the Y
Combinator SAFE note agreement. These definitions can
be defined otherwise and may be interpreted differently.

Valuation Math
Definitions:

Equity Financing: an equity financing where a startup

issues Standard Preferred Stock with a specific
company valuation (typically a Series A financing).

Standard Preferred Stock: shares of preferred equity

issued to new investors in the company as part of the
equity financing.

In an Equity Financing, the investor of Standard Preferred

Stock will attribute a certain value to the entire company
(known as the company valuation). Unlike in a SAFE note
agreement, in an Equity Financing, the new investor
agrees to purchase an interest in the company at the price
of the company valuation.

The two key terms that founders should know when it

comes to valuation math is Pre-Money Valuation and
Post-Money Valuation.

Pre-Money Valuation: The valuation price before the

new offering.

Post-Money Valuation: The valuation price after the

 new offering.

Capital Invested: The capital invested at the time of

the Preferred Stock offering plus any convertible
instruments not yet converted into equity (including
SAFE notes)

Purchase Amount: The capital invested in a specific

investment instrument (e.g. SAFE note, Series A
preferred stock, etc.)

Company Capitalization: the number of shares a

company has outstanding prior to an equity financing.
These shares include shares of Capital Stock, shares
from Converting Securities, Options, and shares from
any Unissued Option Pool.

Similar to Part 1 of the SAFE note post, let’s assume the

following:

The Pre-Money Valuation is used to calculate the

number of shares issued to an investor.
 Example: Assuming a Series A financing has a Pre-
Money Valuation of $15 million and a Company
Capitalization of 1 million shares, the price per share
for the Series A financing will be $15.00 per share.

By dividing the Purchase Amount by the price per

share, an investor will arrive at the number of shares
they will receive in the financing.

Example: Assuming a Series A financing has a

Purchase Amount of $5 million at a $15.00 per share
price, the Series A investors will receive 333,333
shares.

The Post-Money Valuation will derive the percentage

ownership investors and management have in the
company following the Equity Financing.

Example: Assuming a Series A financing has a

Purchase Amount of $5 million and a Post-Money
Valuation of $20 million, the Series A investors will
own 25% of the company ($5 million Purchase
Amount divided by $20 million Post-Money
Valuation)

Standard Preferred Stock vs. SAFE

Preferred Stock
During an Equity Financing, SAFE note investors will
convert their investment into a “sub-series” of preferred
stock called SAFE Preferred Stock that is separate from
the shares issued to the Standard Preferred Stock
investors. SAFE Preferred Stock is typically given a similar
name to that of Standard Preferred Stock. For example:
Series A-1 preferred stock vs. Series A preferred stock.

Below are high-level differences between the two

series of preferred stock. I will provide additional
detail on liquidation preferences, dividends, and
rights in my post on preferred equity — stay tuned!

Similarities: Both series of preferred stock will have

the same rights, privileges, preferences, and
obligations as Standard Preferred Stock.
Differences: The liquidation preference, conversion
price, and dividend rate are calculated based on the
price per share of SAFE Preferred Stock.

Equity Financing
Please refer to Part 1 of the SAFE note post for further
detail on Equity Financing events.

As highlighted in Part 1 of the SAFE note post, an Equity

Financing is an event where a SAFE note investor will
convert their investment into shares of preferred stock.
The number of shares issued to the SAFE note investor
will depend on if the agreement includes a Valuation Cap,
Discount Rate, or both.
Note to Reader: All examples provided herein are
illustrative and may not be representative of your
company’s situation.

Most Favored Nation (MFN) Provision

For SAFE note agreements without a Valuation Cap or
Discount Rate, the agreement typically includes an MFN
provision. The MFN provision provides protections to the
SAFE note investor, including:

If the company subsequently issues SAFEs with

provisions that are advantageous to the investors
holding this SAFE (such as a valuation cap and/or a
discount), this SAFE can be amended to reflect the
terms of the later-issued SAFEs. The MFN provision
typically provides only one opportunity to amend the
original SAFE.
The SAFE note will not automatically convert during
an Equity Financing unless the financing above a
certain threshold (typically $250,000). The threshold
protects the SAFE note investor against an
insignificant equity financing raised at an artificially
high valuation.

Valuation Cap: the maximum valuation a SAFE note

investor will pay at the time of an Equity Financing.

SAFE Price: equal to the Valuation Cap divided by the

Company Capitalization.
 Discount Rate: In conjunction or in lieu of a Valuation
Cap, investors may negotiate a Discount Rate in their
SAFE note. The Discount Rate is displayed as 1 minus
the discount (typically 0%-20%).

Discount Price: The Standard Preferred Stock price

multiplied by the Discount Rate.

Conversion Price: either the Standard Preferred

Stock price, SAFE price, or Discount Price, whichever
results in the greatest number of preferred shares.

No Valuation Cap, No Discount Rate

Illustrative Example by Mario Ruiz

Series A Investors:

Example: Series A investors will receive shares based

on a Pre-Money Valuation of $15 million. Assuming a
Company Capitalization of 1 million shares, they will
pay $15.00 per share of Series A preferred equity.
Assuming a Purchase Amount of $5 million, the
$15.00 per share price will grant Series A investors
333,333 shares of Standard Preferred Stock.

SAFE Note Investors:

 Example: In this example, the SAFE note investors do
not have a Valuation Cap or Discount Rate. Therefore
the SAFE note investors’ Conversion Price is the
Series A valuation of $15.00 per share.
Assuming a Purchase Amount of $1 million, the
$15.00 per share price will grant SAFE note investors
66,667 shares of SAFE Preferred Stock.

Pro Forma Ownership:

Using the assumptions above, 400,000 new shares

will be issued to Series A and SAFE note investors.
Pro forma for the Series A Equity Financing, Series A
investors will own 23.8% of the company (333,333
shares divided by 1.4 million shares) and SAFE note
investors will own 4.8% of the company (66,667
shares divided by 1.4 million shares).
Management and other existing shareholders will
retain the remaining 71.4% of the company.

Yes Valuation Cap, No Discount Rate

Illustrative Example by Mario Ruiz

Series A Investors:

Same as the first example, the Series A investors will

receive 333,333 shares of Standard Preferred Stock.

SAFE Note Investors:

Example: In this example, SAFE note investors have a

Valuation Cap of $10 million which is lower than the
Series A Pre-Money Valuation of $15 million.
Therefore, the SAFE note investors’ Conversion Price
is the SAFE Price of $10.00 per share.
 Assuming a Purchase Amount of $1 million, the
$10.00 per share price will grant SAFE note investors
100,000 shares of SAFE Preferred Stock.

Pro Forma Ownership:

Using the assumptions above, 433,333 new shares

will be issued to Series A and SAFE note investors.
Pro forma for the Series A Equity Financing, Series A
investors will own 23.3% of the company (333,333
shares divided by 1.433 million shares) and SAFE
note investors will own 7.0% of the company
(100,000 shares divided by 1.433 million shares).
Management and other existing shareholders will
retain the remaining 69.8% of the company.

No Valuation Cap, Yes Discount Rate

Illustrative Example by Mario Ruiz

Series A Investors:

Same as the first example, the Series A investors will

receive 333,333 shares of Standard Preferred Stock.

SAFE Note Investors:

Example: In this example, SAFE note investors have a

Discount Rate of 80%. Assuming a Series A preferred
equity price of $15.00 per share, the SAFE note
investors’ Conversion Price is the Discount Price of
$12.00 per share ($15.00 per share x 80% Discount
 Rate).
Assuming a Purchase Amount of $1 million, the
$12.00 per share price will grant SAFE note investors
83,333 shares of SAFE Preferred Stock.

Pro Forma Ownership:

Using the assumptions above, 416,667 new shares

will be issued to Series A and SAFE note investors.
Pro forma for the Series A Equity Financing, Series A
investors will own 23.5% of the company (333,333
shares divided by 1.417 million shares) and SAFE note
investors will own 5.9% of the company (83,333
shares divided by 1.417 million shares).
Management and other existing shareholders will
retain the remaining 70.6% of the company.

Yes Valuation Cap, Yes Discount Rate

Illustrative Example by Mario Ruiz

Series A Investors:

Same as the first example, the Series A investors will

receive 333,333 shares of Standard Preferred Stock.

SAFE Note Investors:

Example: In this example, SAFE note investors have a

Valuation Cap of $10 million and a Discount Rate of
80%. Since the Valuation Cap SAFE Price of $10.00 is
lower than the Discount Price of $12.00 per share
and the Series A preferred equity price of $15.00 per
 share, the SAFE note investors’ Conversion Price is
SAFE Price of $10.00 per share.
With a Purchase Amount of $1 million, the $10.00 per
share price will grant SAFE note investors 100,000
shares of SAFE Preferred Stock.

Pro Forma Ownership:

Using the assumptions above, 433,333 new shares

will be issued to Series A and SAFE note investors.
Pro forma for the Series A Equity Financing, Series A
investors will own 23.3% of the company (333,333
shares divided by 1.433 million shares) and SAFE
note investors will own 7.0% of the company
(100,000 shares divided by 1.433 million shares).
Management and other existing shareholders will
retain the remaining 69.8% of the company.

Liquidity Event
Please refer to Part 1 of the SAFE note post for further
detail on Liquidity Events.

Note to Reader: All examples provided herein are

illustrative and may not be representative of your
company’s situation.

Liquidity Event: an event whereby there is a Change

of Control in the company (ex. a sale or merger) or an
Initial Public Offering (IPO).
 Proceeds: cash, stock, or other forms of
consideration provided from a Liquidity Event or
Dissolution Event.

Illustrative Example by Mario Ruiz

In a scenario where there’s a Liquidity Event before

the termination or conversion of the SAFE note, SAFE
note investors will receive Proceeds equal to the
greater of:

1. The amount invested in the SAFE note (Purchase

Amount). For example, if a SAFE note investor invests
$1 million, the Purchase Amount is equal to $1 million.
2. The acquisition price per share multiplied by the
 shares of common stock equal to the Purchase
Amount divided by the SAFE Price.

As shown in the example above, the SAFE note

investor would select option #2 since it generates the
highest Proceeds.

If a SAFE note agreement does not include a Valuation

Cap, then the value of the SAFE note in option #2 will be
determined by the fair market value of the common stock
at the time of the Liquidity Event. The fair market value is
typically determined by a third-party firm. For SAFE note’s
with a Discount Rate, the Discount Rate will be applied to
the fair market value of the common stock price.

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