Global Founders' Headache #3: Raising your first SAFE round in 5 steps

This is the 5 steps guide to help you manage strategically, efficiently and professionally your SAFE round, alone!!

There is nothing rocket science about raising a SAFE round. The golden rule to apply is: to keep it simple, market standard, and systematic.

VC is all about taking big risks for big returns. That's why we aim to make the first round of funding quick and straightforward—no long negotiations or piles of paperwork. This need for speed is exactly why Y Combinator came up with the SAFE, making it easier and faster for startups to get the investment they need to grow.

In this post, I'm not explaining how to attract capital, you got this 💪. Instead, I'll guide you through managing your first SAFE round for a Delaware company, providing educational content and tools to get it done.

→ Follow 5 steps to minimize SAFE round admin hassle and manage your round like a pro:

I hope this helps you stay in control of your funding round, allowing you to close it smoothly and get back to building your dream company!

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Step 1: Build a Business Plan

This is an interesting exercise even if we know it is fairly fictional. Think of it as an opportunity to ask yourself critical questions about building and growing your business. 

The business plan will help you determine and rationalize your target round size.

There are two options: 

1. Determine how much money you need for 18 months = your fundraising target. 

2. Determine how much money you need to build your proof of concept = your fundraising target. 

Setting your target fundraising amount is crucial for attracting the right investors. For instance, if you need $200,000 to build your proof of concept, avoid approaching institutional investors who prefer writing larger checks for a minimum of 15-20% equity in the company.

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Step 2: Understand the Key Terms

To be able to negotiate your round, you need to understand the SAFE conversion mechanisms and the additional rights investors may ask in a side letter. 

Reminder: A SAFE is a financing instrument that allows investors to convert their $$$ into equity at a later date, typically triggered by a future funding round, at a predetermined valuation cap or discount.
💡 Investors are taking a bet early, at a time when it is difficult to determine the valuation of the company. 
💡 Their bet is that you will raise at a valuation higher than the valuation cap. 
💡 Investors don't receive any shares until you raise an equity round. It's quick and simple, light paperwork (YC forms), no legal fees. 

Conversion mechanisms

Pre-Money vs Post Money 

Until 2018, pre-money valuation SAFEs were standard, but their complex conversion issues led YC to switch to post-money SAFEs.

The essence of using SAFEs is to cut through administrative hassles, enabling founders to move quickly, innovate, and find product-market fit before diving into detailed financial negotiations. 

Post-money SAFE = Clear Ownership

Post-money SAFE makes it simpler and clearer for everyone involved to understand ownership: you know exactly what percentage of the company is owned by investors after the SAFE converts.

💡 Why? SAFE holder ownership is calculated after accounting for SAFE funds (post ;-)) but before the equity from the next funding round dilutes it, typically a Series A or Series Seed equity round.

Pre-money SAFE = Ownership keep changing

With pre-money SAFE, each time you raise a SAFE, the previous SAFE holders are diluted. You think that may be advantageous for founders to minimize their dilution…. it’s not. It only creates a huge admin neightmare for the conversion and makes it harder to anticipate how much percentage of the company you sold to investors. You’ll waste time with lawyers modeling it out and create confusion with your investors!

💡 Why? Initially SAFEs were meant to raise bridge rounds before your first fundraising or in between rounds. They were so popular that founders raised pre-seed and seed round only with SAFE, often over a 1-3 years, with different valuations. Stacking up SAFEs and diluting previous investors without keeping track of the dilution..

📚 If you're interested in diving deeper into conversion calculation of post vs. pre-money SAFE, check out YC Guide and this blog post.

Valuation Cap and Valuation Floor 

The standard is to have only a valuation Cap. There is no valuation floor in the YC standard SAFE, in the spirit of keeping things simple.

The valuation cap sets the maximum valuation at which your SAFEs will convert, with conversion triggered by an equity financing event. SAFE investors are essentially betting that this cap will be lower than the valuation assigned during the equity round. Remember, the purpose of a SAFE is also to reward early investors for taking a bet on you!

🌍 However, valuation floor is a term common in Europe and West Africa. This is useful in case you don’t raise an equity round triggering the conversion of the SAFE. It sets the minimum valuation at which the SAFEs are going to convert. You obviously don’t want to be in this scenario, but that’s a way to plan for it by agreeing on the lower valuation with your investors.

Discount 

In a YC SAFE note, a discount gives investors a price reduction on future equity based on the company's valuation in the next funding round.

For example, if the next funding round values the company at $10 per share and the SAFE note includes a 20% discount, SAFE investors can buy shares at $8 each ($10 - 20%). In other words, if the company’s valuation for the funding round is $10M, SAFEs will convert at a discounted valuation of $8M.

⚠️⚠️ ⚠️ You can mix a valuation cap with a discount, so that the conversion method giving investors more shares kicks in. It's a great way to encourage investors, essentially promising them, "At worst, you'll get a discount on the next equity round's valuation." This approach is especially handy for bridge rounds.

MFN (Most Favored Nation)

It’s the secret weapon of the investor to be protected no matter what happens. YC uses it too ;-)

The MFN provision means that if the company issues a new SAFE with better terms (e.g., a lower valuation cap or a higher discount), the early SAFE investors can choose to adopt those improved terms.

For example, suppose an investor receives a SAFE with a 20% discount. If the company later issues a SAFE with a 30% discount, the MFN provision allows the original investor to switch to the 30% discount.

Side Letters

Investors frequently ask for additional rights, such as :

• pro-rata rights: it’s a right for an investor to participate in the future financing round to maintain its original ownership percentage. The new round would otherwise dilute its original ownership.

• information rights: regular updates, financial reporting, access to key metrics

• governance rights: board seat or board observer

⚠️ ⚠️ ⚠️ Always read side letters carefully—they can be packed with various rights and obligations. Unless it's a standard YC side letter, which typically only includes pro-rata rights, make sure to consult with a lawyer before signing any side letter!

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Step 3: Build Your First Captable

Steps 1 & 2 are preparatory work to help you build your first captable.

Excel takes you pretty far

Now, let’s help you think about valuation, dilution, and captable dynamics to be prepared to talk to investors.

The question you want to answer is simple: how much of the business are you willing to sell and at what price?

To help you think that through, start by building a simple Excel captable. If you are organized enough, you don’t need to purchase expensive captable software until your equity round.

• Model founders ownership. How do you want to split the ownership?

• Model your equity plan to incentivize employees and advisors.

  💡 To determine the size of the plan, the general rule of thumb here is to create an option pool big enough to incentivize your employees/advisors until your equity financing.

• Model SAFEs conversion. It will help you figure out the valuation.

Uff, I do love software, 👋 Dilution Assistant

There's a growing trend to boost a company's valuation based on investor demand. Logically, as more investors show interest in buying shares, the company's valuation rises.

If you raise multiple SAFE rounds with different valuation cap, it’s crucial to monitor dilution. Keeping tabs on this will ensure you maintain significant ownership to be in the best position to raise your Series A.

The general rule of thumb about ownership is: 

• Pre-seed & Seed Dilution: 20%-30% dilution before your first equity round 

• Founders/Employees Ownership: They should own around 60% of the company at the Series A

• Lead investors Allocation Target: Leads want to own 15-20% of the company 

🤖 I do love software, so I built this simple Dilution Assistant to control ownership as you raise SAFEs. Use it each time you raise additional SAFEs!!

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Step 4: Build Your SAFE Tracker

Again, here Excel takes you pretty far. You can build a simple tracker to stay organized as you kick off your fundraising:

• name of investor

• date of investment

• terms

• emails

• signature block (i.e. name of the entity, name of the signatory)

• tracking signature

• tracking wires

⚠️⚠️⚠️ As soon as an investor commits, you want to follow up with the SAFE form, the wire instructions, and a wiring deadline. The ball is in your court to keep the momentum and close the round! This tracker will help you collect all relevant information to move to the final step: CLOSING!

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Step 5: Closing with Your SAFE Assistant

If you completed steps 1-4, this final stretch home to close the round should be suuuuuuuper smooth.

Keep it simple, use YC SAFE Forms

I highly recommend using the YC standard SAFEs forms available on their website.

Automate your closing with a SAFE Assistant

To manage the admin side of things for closing, there are several tools available online. For example, AngelList and Mercury built SAFE generators as a perk for their users. Alternatively, tech law firms, Orrick’s Tech Studio or Cooley Go offer similar tools.

I compared them all, added my magic touch, and built my own to issue SAFEs, side letters and get the round approved by the Board: SAFE-X, your SAFE Assistant.

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Let’s Recap the 5 Steps

⚠️ ⚠️ ⚠️ This doesn’t replace legal advisory. If you need to negotiate special terms or if you have any questions specific to your situation, it will be money well invested to hire a professional. You are investing to get smarter about a critical part of your entrepreneurial journey: raising capital!

You are all set to raise your first SAFE round like a pro 😃

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Disclaimer: nothing in this blog post should constitute legal or tax advices, use it to educate yourself and hire experts.

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