Startup Investing 102: Understanding ,pre-money, post-money, SAFEs

Mar 07, 2024

Create a visually appealing and soothing image that symbolizes funding for startups, with a focus on depicting a flow of coins or notes leading into a modern building to represent a company. The building should be a minimalist and stylized representation of a corporate structure, illustrating the growth and development of a startup through financial investments. Use soft, calming colors and a minimalist design to convey the concept of startup funding in an aesthetic and easy-on-the-eyes manner.

Picking up from where we left off on startup investing, let's explore strategies investors use to invest capital into startups. Knowing the intricacies helps whether you're eyeing your next investment or prepping your startup for funding.

Pre-Money Valuation

Think of pre-money valuation as the value of a startup before new money comes in from investors. It’s like appraising the price of a used car before you decide to give it a new paint job or add any upgrades. If a startup is said to have a pre-money valuation of $10 million, it means that’s what the business is worth before anyone else puts in more money.

Post-Money Valuation

Now, post-money valuation is a bit different. It includes the new money that investors are putting in. Using the same used car analogy, this would be like valuing the car after all the upgrades and new paint job are done. So, if that startup has a post-money valuation of $10 million, and you invest $1 million it is already included in the $10 million.

Here’s another interesting way of looking at it:

Pre-Money: Think of a company like a pie worth $10 million before investing any money. If you then invest $1 million, it's like adding your slice to the pie, making the whole pie worth $11 million now. Since you added $1 million to the $10 million pie, you own about 1 slice of an 11 slice pie, which is around 9% of the company.
Post-Money: Imagine the company's pie is already worth $10 million, and that includes your $1 million piece. So, you're not adding to the pie's value; you're part of it from the start. It's like the pie is already cut into 10 slices, and your $1 million buys one of those slices. You own 1 out of 10 slices, or 10% of the company.

SAFEs: Simplified Future Equity

Imagine investing without the hassle of calculating interest rates. That's where SAFEs (Simple Agreements for Future Equity) come in. These agreements allow investors to convert their funds into equity during future financing rounds under conditions agreed upon initially.

For example, consider you’re investing in a startup projected to be worth $10 million in the future. As a SAFE investor, you could agree that your $25,000 investment converts into shares based on a $5 million valuation on a future funding round. This “valuation” is the company's perceived worth at the time of the future investment round for the investor. A SAFE allows you to lock in a favorable rate, recognizing the higher risk you took by investing early compared to new investors who enter at a $10 million valuation.

Valuation Cap and Discounts

SAFEs typically feature a valuation cap or discount — sometimes both.

Valuation Cap: This cap ensures that you, as an early SAFE investor, can convert your investment into equity at a more favorable valuation compared to new investors in a future round. If the company is later valued at $10 million but your SAFE included a $5 million valuation cap, your $25,000 investment buys you twice as many shares as someone investing $25,000 in the new round. This is lucrative as the early investor would want better returns for the additional risk he is taking.
Discount: This offers SAFE investors a discount rate when converting their investment into shares, compared to the price new investors pay. This is generally 20% in the VC industry. So, the Safe investors pay 20% less for the same stock as the new investor.

Create a visually appealing and soothing image that symbolizes funding for startups, with a flowing stream of coins or notes leading into a building representing a company. The building should embody the growth and development of a startup through financial investment. Use soft, calming colors and a minimalist design to convey the concept of startup funding in an aesthetic and easy-on-the-eyes manner, replacing the traditional imagery of a tree with a modern startup building.

Pre-Money vs. Post-Money SAFEs

In a nutshell, pre-money valuation doesn’t include your SAFE invesment, while post-money valuation does. Knowing the difference can help you understand how much of the company you own after your investment. It’s that extra difference in the denominator that makes the difference mathematically.

Final words

SAFEs offer a flexible, interest-free way to participate in a company's growth, with terms like valuation caps and discounts to protect early investors. Understanding the nuances between pre-money and post-money SAFEs can significantly impact your investment outcome. As always, the key to startup investing is knowledge – ensuring you know exactly what terms you agree to and how they align with your investment strategy.

Please share the post if you found it helpful. It encourages me to bring out bite-sized valuable content. See you in the next one!

Inkwell

Discussion about this post