News & Events


Changes in Convertible Instruments for Early Stage Financings

By Procopio Partner Roger Rappoport and Senior Associate Aaron Sokoloff

There are currently two main types of convertible instruments that are in widespread use for pre-Series A and other “bridge” financings: convertible promissory notes and SAFEs (Simple Agreements for Future Equity). Each of which are alike in that the amounts invested under the applicable instrument convert into shares of the issuing company in question, upon the happening of certain events, which is most often a significant round of funding led by institutional investors. The SAFE, developed by the high-profile Silicon Valley accelerator Y-Combinator, captures the essential economic terms of convertible notes without carrying actual debt, accruing interest or a maturity date (any of which can be problematic for startups, while generally adding little practical value for investors), and has become increasingly popular.

While the standard terms of convertible notes have remained fairly constant over the years, Y-Combinator has recently made significant changes to their standard form of SAFE, recasting it as a “Post-Money SAFE.” Both founders and investors should be aware that the Post-Money SAFE differs from the old form (the “Pre-Money SAFE”) in ways that could have a major impact on the economics of the transaction and ultimately the founders’ and other early investors’ ownership.

While startups and investors often enter into SAFEs without reading the “fine print,” it is important that both investors and founders understand the terms and conditions of these instruments. In particular, founders who sell Post-Money SAFEs, without understanding the ramifications of the terms, may be setting themselves and early investors up for far more dilution than they realize, and investors who are not aware of or don’t understand the differences and nuances of the Post-Money SAFE may not be in the best position to negotiate reasonable terms that are ultimately fair to both parties.

Although there are many, the most notable change in the Post-Money SAFE comes into play when the amounts invested under SAFEs convert in a preferred stock financing at the Valuation Cap (which is the pre-money valuation negotiated by the parties at the time of the issuance of the SAFE that is used to compute the conversion price of the amounts invested under SAFEs). Unlike the Pre-Money SAFEs (or most convertible notes), the conversion price of the Post-Money SAFE is calculated in a way that takes into account the total amount of SAFEs that are converting (plus any and all other convertible securities converting in connection with the financing, such as convertible promissory notes).

While a discussion of the calculation mechanics is beyond the scope of this article, the key point for founders and investors to be aware of is that, with the Post-Money SAFE, the higher the amount of SAFEs a company issues (and all other convertible securities, such as convertible promissory notes that will convert in connection with the Company’s next financing), the lower each individual SAFE’s conversion price will potentially be. Thus, issuing a higher amount of Post-Money SAFEs (and convertible promissory notes) can result in significantly more dilution to the founders and early investors when the SAFEs convert in a financing.

Founders and early investors are able to compensate for this, to a degree, by setting higher valuation caps to account for the fact that the SAFEs (and convertible promissory notes) “feed in” to the conversion calculation. However, we suspect this may not often occur in practice, especially if investors are not familiar with the differences between the Pre-Money SAFE and the Post-Money SAFE. We believe that investors may balk at caps that seem “too high” relative to what they are accustomed to for a company at a particular stage in its lifecycle, and may disregard the distinction that these caps are being set on a post-money basis instead of the traditional pre-money basis. It is therefore imperative that not only should founders make themselves familiar with the differences and nuances of the Post-Money SAFE (and the implications thereof) so that they understand the questions to ask, but investors should too, since it is going to require an understanding of such differences to agree on deal terms that are reasonable and equitable to all.

There are other important nuances in both the Pre-Money SAFE and the new Post-Money SAFE. However, having worked with numerous clients doing SAFE financings, we believe it is particularly important for founders and early investors considering SAFE financings to be aware of the fundamental valuation and conversion terms with Post-Money SAFEs.

Note: the foregoing article is not intended as an endorsement or a recommendation regarding SAFEs, Y-Combinator, or any of its offerings.


Roger C. Rappoport is a Partner at Procopio and the leader of the Emerging Growth & Venture Capital Practice Group. He has extensive experience advising emerging growth companies, from inception through exit, and the investors that finance them. Roger’s practice focuses on venture capital and angel investor financings (including convertible notes, SAFEs and other debt financings), mergers and acquisitions, joint ventures, distribution, development, manufacturing and licensing transactions, executive compensation, including the establishment of equity incentive plans and general corporate governance. Roger is a frequent speaker on topics related to “doing it right” from inception, developing an appropriate funding strategy and negotiating term sheets. He has experience with clients in a diverse array of industries including software (B2B and B2C), hardware, communications, internet, renewable energy, medical devices, med-tech, biotechnology, and pharmaceuticals. Prior to becoming an attorney, Roger was an entrepreneur for 10 years.

Aaron Sokoloff is a Senior Associate at Procopio and a member of its Emerging Growth & Venture Capital, Corporate & Securities, and M&A and Strategic Joint Ventures practice groups. He counsels clients on venture financings, seed financings, bridge financings, and exits. He is also experienced advising entrepreneurs on company formations and advising technology companies on general corporate and legal issues, including contracts, equity compensation, and corporate governance. In addition, Aaron is leading the efforts of Procopio’s Business & Technology team on practice improvements, knowledge management, and attorney education.