Pre vs. Post-Money SAFE Valuations: What you need to know
Nov 25, 2023
Pre-Money vs. Post-Money Valuation Caps on SAFEs: Simplified for Startup Founders
When deciding to fundraise for your startup using SAFEs (Simple Agreements for Future Equity), understanding the difference between pre-money and post-money valuation caps is crucial.
This post will briefly explain the difference between Pre and Post-Money valuation caps, and when you should use them in your fundraising journey.
Pre-Money Valuation Cap: This is the company's valuation before the investment is made. It sets a limit on the valuation at which an investor's money converts into equity. This means investors know their ownership percentage upfront, based on the cap and the amount invested.
Post-Money Valuation Cap: Introduced more recently, this considers the SAFE investment as part of the company valuation. It calculates ownership percentage based on the total company value after including the SAFE investment. This offers more clarity to founders about how much ownership is being given away.
Choosing between pre-money and post-money valuation caps impacts how much equity investors get. Pre-money caps can be more founder-friendly in fast-growing startups, while post-money caps provide clearer future ownership structure.
A quick hypothetical example
In the Pre-Money Scenario: Initech Solutions, valued at a pre-money cap of $5 million, caught the eye of investor Alex, who decided to invest $1 million. This investment brought Initech's total valuation to $6 million. Despite the increase, Alex's share was calculated based on the initial $5 million cap, giving him a 20% stake in the company.
This scenario meant that as Initech continued to grow and raise more funds, the founders faced more dilution.
In the Post-Money Scenario: This time, Initech and Alex agreed on a post-money cap of $5 million. Alex's $1 million investment was included in this valuation. Therefore, Initech valuation immediately after the investment remained $5 million. Alex still received a 20% stake, but the key difference was in the company's valuation after his investment, which remained fixed.
This provided a clearer and more predictable understanding of equity distribution for future rounds, offering more stability to Initech's founders.
Understanding these differences is vital for making informed decisions in your funding strategy. Not fully understanding how these mechanism can dilute your ownership stake can lead to negative downstream impacts on your exit.