Pre-Money vs Post Money Conversion
In 2018 YC replaced the original Pre-money safe (where investors and company agree on the pre-money valuation) with the Post-money safe (where investors and company agree on the post-money valuation the safe converts). The key difference between the two conversion methods is around calculating the ownership being sold in an investment:
- If an investor and company agree on a pre-money valuation, then an investor’s ownership is a function of their investment, the pre-money valuation and the size of round (and all other rounds until conversion).
- But if an investor and company agree on a post-money valuation, then an investor’s ownership is a function of their investment and the post-money valuation irrespective of the round size or any other rounds taking place until conversion.
For a company raising just one SAFE round, there’s effectively no difference: an investor who invests $2M on $8M pre-money is presumably willing to invest $2M on $10M post-money, with the same resulting ownership of 20%. But things are different when multiple SAFE rounds are involved. Let’s look at two examples
Conversion on a Pre-money Basis
Consider a company that’s in the example above. The company first issues a $2M SAFE converting on a pre-money basis. The company cap table looks as follows
| Starting ownership (shares) | Starting ownership (%) | First Safe Round | Ownership after everything converts (shares) | Ownership after everything converts (%) | |
|---|---|---|---|---|---|
| Founder A | 1,000,000 | 50% | 1,000,000 | 40% | |
| Founder B | 1,000,000 | 50% | 1,000,000 | 40% | |
| Seed Investor | The right to buy 2/(8+2) = 20% of equity | 500,000 | 20% | ||
| 2,000,000 | 100% | 2,500,000 | 100% |
Now the same company decides to raise an additional $2M on the same terms a year later from Seed Investor 2. Under the pre-money conversion, the company will have effectively raised two different $2M notes on $8M pre-money, so effectively $4M on $8M pre/$12M post, with Investors owning 33.33% and founders 66.66%. Basically, in a pre-money conversion, investors dilute each other in addition to diluting existing shareholders.
| Starting ownership (shares) | Starting ownership (%) | First Safe Round | Second Safe Round | Ownership after everything converts (shares) | Ownership after everything converts (%) | |
|---|---|---|---|---|---|---|
| Founder A | 1,000,000 | 50% | 1,000,000 | 33.33% | ||
| Founder B | 1,000,000 | 50% | 1,000,000 | 33.33% | ||
| Seed Investor 1 | The right to buy 2/(8+2) = 20% of equity | The right has now changed to be 2/(8+2+2) = 16.66% | 500,000 | 16.66% | ||
| Seed Investor 2 | The right to buy 2/(8+2+2) = 16.66% of equity | 500,000 | 16.66% | |||
| 2,000,000 | 100% | 3,000,000 | 100% |
Cap Table Example
Here’s the mechanics of what actually happens:
- Initially, investor 1 bought the right to buy $2M of equity on $8M pre (or $10M post)
- Then Investor 2 got the right to buy $2M of equity on $8M pre. But the company is now valued at $12M post. So Investor 2 gets 2/12 = 16.66%. Additionally, investor 1’s ownership is getting diluted by Investor 2’s 16.66%. So now their ownership is 20% * (1-0.1666) = 16.66%
The dilution keeps going on as the company raises additional convertible or SAFE rounds until the first priced rounds takes place. And the math is recursive—getting a bit more complicated with each round. And that’s why investors and founders demanded a better mechanism.
Conversion on a Post-money Basis
Let’s take the same example but where investors agree on the post-money valuation. Under this scenario, each investor will have invested $2M on $10M post for a 20% ownership. The company will have effectively raised $4M on $10M post with investors owning 40% and founders 60%. Why the difference? Because in post-money agreement, the second SAFE investor dilutes the existing shareholders but do not dilute the first SAFE holders since the agreement is on the post-money not the pre-money.
| Starting ownership (shares) | Starting ownership (%) | First Safe Round | Second Safe Round | Ownership after everything converts (shares) | Ownership after everything converts (%) | |
|---|---|---|---|---|---|---|
| Founder A | 1,000,000 | 50% | 1,000,000 | 30% | ||
| Founder B | 1,000,000 | 50% | 1,000,000 | 30% | ||
| Seed Investor 1 | The right to buy $2M/$10M = 20% of equity | 666,666 | 20% | |||
| Seed Investor 2 | The right to buy $2M/$10M = 20% of equity | 666,666 | 20% | |||
| 2,000,000 | 100% | 3,333,333 | 100% |
Conclusion
Post-money conversion offers investors and founders clarity on their respective ownership before priced round occurs, while pre-money conversion provides more favorable dilution to founders across multiple rounds. That said, that ship has largely sailed. In recent years, pre-money SAFEs and convertible rounds have virtually disappeared, with post-money SAFEs now dominating over 95% of Silicon Valley financing.