Is it SAFE?
Sure, they're super-easy, but... what's the catch?
TL;DR: The popularization of Safes have brought with it some painful side-effects: dilution being pushed entirely on founders, legal mistakes costing more to fix, and – paradoxically – the cost of legal services going up.
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Safes can be sneaky
You’re raising money on Safes, round after round, and you’re not keeping tally of how much of your company you’ve sold.
Worse yet – the investors in each round are not being diluted in each successive round – only you are.
And then the time comes to raise your first priced round (also known as a Series Seed).
This is when you’re in for a rude awakening.
You hire an attorney to get the ball rolling, she prepares your pro forma cap table, and for the first time since starting your company, you realize exactly how much of it you’ve sold: over half.
The culprit?
Stacked Safes.
Let’s turn the page for more.
But in case this is all new to you…
I’d like to define a few concepts:
A Safe is a type of investment contract where the investor invests money in return for obtaining a company’s shares in the future, at preferential terms. I dive deep into Safe dynamics here.
A priced round is a fundraising round where the company gets a formal valuation and shares are issued in return for money invested.
A pro forma cap table shows who owns how much of the company after the priced round closes – after the new investors join. As a result, it also shows dilution.
In turn, dilution is the “shrinking” of a stockholder’s ownership percentage. For example, a founder may originally own 50% of the company, but after shares are sold to new investors, that percentage may shrink to 40% –> that’s dilution.
What are stacked Safes?
Stacked Safes are when a company does multiple Safe rounds at different valuation caps. Here’s an example of a company’s fundraising journey with “Stacked Safes”:
Scenario 1
May 2024 (Safe): Raised $500,000 on a $5M valuation cap
December 2024 (Safe): Raised $1M on a $10M valuation cap
October 2025 (Safe): Raised $3M on a $15M valuation cap
June 2027 (Priced round): Raised $4M at a $20M valuation
The money raised in 2024-2025 were all done through Safes with a valuation cap. These are “Stacked Safes”. By contrast, the money raised in 2027 was done through a priced round.
Why is this painful?
Let’s look at these numbers again and figure the ownership percentage that is being sold in each round. I’m using exact numbers here for simplicity.
May 2024: 10% (or $500,000 divided by $5M)
December 2024: 10%
October 2025: 20%
June 2027: 20%
By the time the founders reach their Series Seed in June 2027, they’ve already sold 40% of their company. At Series Seed, they’ll sell another 20%, for a whopping dilution of 60%.
How did we end up here?
Post-money valuation cap Safes have built-in anti-dilution. What that means is that the investor’s ownership percentage is not being diluted when the company raises follow-on rounds. It only starts being diluted when the Safe converts into shares, which happens in a priced round.
To add some color to this: the investors that invested in May 2024 thought they were buying 10% of a $5M dollar company. They would be very pleasantly surprised to find out that they, in fact, purchased 10% of a $20M (which is the valuation of the company when it did it’s first priced round).
You see, that 5% stays “untouched” – locked, so to speak – until the company does a priced round. Only after that priced round does this 5% start being diluted in future rounds.
What could have been done differently?
Let’s assume we’ve had this fundraising journey instead:
Scenario 2
May 2024 (Safe): Raised $500,000 on a $5M valuation cap Safe
December 2024 (Priced round): Raised $1M at a $10M valuation
October 2025 (Priced round): Raised $3M at a $15M valuation
June 2027 (Priced round): Raised $4M at a $20M valuation
In this scenario, the company uses Safes only for the first raise, selling 10% of the company. These convert into shares in the December 2024 priced round and, moving forward, are diluted in future rounds. The investors who joined in December 2024, May 2025, and June 2027 are also each diluted by future rounds.
In real terms, what would have been the difference?
By avoiding stacking Safes, instead of having sold 60% of the company upon closing the 2027 round, the founders would have sold 49%.
And 11% of a $20M company is $2.2M. That’s $2.2M less value for the founders and early team.
The truth is, however, that that $2.2M is the “floor” of the damage caused to the founders. Assuming the value of the company goes up, that damage will increase as well.
What are some other problems with stacked Safes?
The popularization of Safes has had other, if unintended, consequences as well.
Legal mistakes go unnoticed for longer
Due diligence is less robust (if at all existent) for pre-seed and seed safe rounds, as a result of which a company's documents continue being subpar (read: a mess) until proper due diligence takes place at a priced round. Hidden legal mistakes pile up and balloon into bigger problems, costing more to fix down the line.
Multiple Safe rounds = algebraic pro formas
When a Safe converts, the Safe investors end up getting preferred stock which are exactly the same as the preferred stock that new investors (investors that are joining in that round) get, except for one thing – their price (and related terms). This is due to the Safe investors having some kind of preference compared to the new investors – the valuation cap and/or discount.
This “other” type of preferred stock is called “shadow series”.
The more rounds of Safes that convert in the next priced round, the more series of shadow preferred stock will need to be issued – which leads to complex pro formas. If these Safe investors have pro rata rights as well…. well, that means the pro forma calculation is akin to calculus to make sure every penny and stock is accounted for.
Series Seed documents have become more complex
Back in the day, Series Seed rounds were completed based on template documents available through SeriesSeed.com – three simple forms to take the round past the finish line.
With the popularization (and stacking) of Safes, the “priced round can” got kicked down the road, so much so that the Series Seed became the new Series A. Normally, NVCA forms are used at Series A, which include at least five documents, each about 10-20 pages in length. With this shift, the NVCA forms started being used for Series Seed as well – leading to the “death” of SeriesSeed.com forms and, thus, inflating up legal bills.
What’s the solution?
Here are a few insights to keep in mind as you embark on (or continue) your fundraising journey.
Consider doing a priced round
If you’re raising $1M or more, consider doing a priced round. The tough part for a priced round is finding a lead investor. You can boost your chances of finding a lead investor by building relationships with potential VC investors early on. Get a monthly newsletter going just for company updates, and ask if potential investors would like to join. That way, when you’re ready to raise your priced round, your potential lead investors will know where you’re coming from.
Work with the right legal team for your priced round
Legal fees for priced rounds have blown up over the past years. Series Seed rounds that cost $100K – formerly unheard of – are becoming more common, and that’s just the company’s counsel’s fees. Again, I look at Safes as the main reason we got here.
That said, it doesn’t have to be this way. Work with a specialized boutique law firm for your priced round; you’ll get the quality of BigLaw firms at a fraction of the cost.
In fact, we’re addressing this problem at Corpora through automated priced rounds: we automate the legal backend, top-tier startup lawyers lead the strategic legal work, and the startup pays a flat fee of $25K.
Consider using Safes with a pre-money valuation cap or a discount
The anti-dilution aspect of Safes is inherent to the post-money valuation cap Safe. A pre-money valuation cap Safe doesn’t have this issue. That said, be cautious when using these as you may end up selling more of your company than you intended, especially if you stack Safes (back to Square 1).
Discount Safes also don’t have this issue. In fact, with Discount Safes, you don’t have to engage in the “valuation cap” determination exercise which, no matter what they say, is perceived as a proxy for your company’s valuation.
Consider using a “dilutable” Safe
Depending on your leverage in the fundraise, you may consider modifying the post-money valuation cap Safe so that investors in each Safe round are diluted by the investment in a future Safe round – much like they would be diluted if the company had done a priced round instead of a Safe round. José Ancer talks about this on his blog, and you can find an example of such a template here.
If you’d like to go with this option, keep in mind that it may introduce friction in your raise since the offered Safe won’t be a “standard” one as the market knows it. Also, make sure you give your investors a clear heads-up that you’ve modified the standard Safe and educate them about what this means, in full transparency and to preempt future misunderstandings.
Safes of good intentions and bad consequences
When the Safe was introduced, the goal was to make raising money frictionless. It was also intended largely for pre-seed rounds and “bridge” rounds (raises bridging two priced rounds). Fast-forward several years, and Safes have taken over the early-stage fundraising landscape and their ease of use has been “paid for” by larger founder dilution, legal mistakes going unnoticed for longer, and consequently, skyrocketing legal fees.
Introducing SAFE Deal Portals
I give stacked Safes a pretty bad wrap in this newsletter – but to keep the record straight: Safes themselves carry a lot of virtue and value for founders. They’re a great fundraising tool, so long as you are well-aware of its ins-and-outs.
So, that being said, I’m thrilled to introduce our latest product: SAFE Deal Portals. Learn more about it in this quick demo.
Startup Ecosystem Member Highlight
Over the past years, I’ve had the opportunity to meet with amazing people who are super passionate about startups. I’d love to introduce them to you through this newsletter, as they can be helpful to you as you start, grow, and scale your startup.
Meet Nathan Klingseis
Nathan is the co-founder and CEO of Cresci Labs, which provides fractional CMO services to early-stage startups and later-stage ventures, with clients including Fortune 500 companies as well.
I really admire what Nathan is building because he’s hands-on. He and I work out of the same co-working space, CTRL Collective in Old Pasadena, and I regularly see him with his sleeves rolled up, structuring a funnel or creating a design on his laptop. Speaking of funnels, that’s one of his fortés!
He’s also a great connector: chat with him for half an hour, and he’s bound to come up with at least three people that you should speak with – and follow it up with introductions.
Connect with Nathan on LinkedIn and check out Cresci Labs’s cool website!
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Until next time!
Stepan
Thank you very much to Dena Medford for reading this post and sharing valuable feedback!
A bit about me: I’m a corporate lawyer with 10+ years of experience helping 100s of companies navigate the legal journey, including early-stage startups and unicorns. I quit my private practice to start Corpora and help founders raise money faster and more affordably. Let’s connect on LinkedIn.