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Pre-Seed Funding with Post-Money SAFEs: Revisited in 2024

There are few markets that evolve faster than the world of startups, for unsurprising reasons. I figured it was time to revisit some of my writings on seed and pre-seed funding given how much the market has evolved since 2019-2021, when I last wrote about this topic in depth.

First, a brief history:

1990s – Long before the term “pre-seed” was even a thing, before the SaaS revolution made it even conceivable to start building a tech company with only a few hundred thousand dollars (or less), almost all early startup funding occurred as a complex preferred stock round; what now is reserved for Series A and larger seed rounds. It was a very different world from today.

Early 2000s  – Then convertible notes, once reserved mostly for “bridge” rounds in between preferred stock financings, started being used for seed funding; a natural evolution for rounds that were getting smaller and couldn’t justify full equity round negotiation time or costs. It worked relatively well. We also saw in this era the emergence of “series seed” preferred stock templates, a slimmed-down version of the more complex NVCA, that allowed you to raise a seed equity round for about 40-50% less in legal fees. These also got a decent amount of traction.

2013 – Then the Pre-Money SAFE, which is a convertible note without interest or maturity (effectively) was released around 2013. Founders started (candidly) abusing that instrument by raising Pre-Money SAFEs for years and years while obscuring the real economics behind what angel investors were funding. This was do-able because if your second, third, or fourth SAFE round has a pre-money valuation cap, but nothing capping the post–money, your newest investors can’t really know what % of the company their investment is buying without making you model out all the conversion math.

They could, for example, be putting in $1 million at a $49 million pre-money cap, which would suggest a $50 million post-money valuation, but they were in fact getting way less than 2% of the business because numerous unmodeled earlier SAFE rounds were pushing up the post-money. The post-money valuation is what really hardens a startup investor’s ownership percentage.

2018 – In late 2018 Y Combinator released the Post-Money SAFE. It flipped the economics of SAFEs to have a post-money cap, making the % purchased by investors far more transparent and immune to this issue of companies obscuring a deal’s economics. This was a good development, and the Post-Money model of valuation caps has since gained substantial market share.

But there’s one very big problem. The solution YC devised went much further – to the benefit of investors (including themselves) –  than was necessary to let investors know what % of the cap table they are buying on the day they invest. It further promised those investors complete non-dilutability of that percentage until the SAFE converts, including through subsequent SAFE rounds with higher valuation caps. This makes the Post-Money SAFE far harsher economically (to founders) than any other instrument in the history of startup finance.

YC itself has made an enormous amount of money by implementing this new math into the deal it gets with its own accelerator’s startups. I’ve seen YC companies start with giving 7% (the usual deal) to YC, but by the time the SAFE actually converts, after two or three more convertible rounds, the YC % is functionally equivalent to having received 10% or more years earlier. The smartest YC companies get ahead of this issue and raise a seed equity round as soon as they can after exiting the accelerator, cutting off this problem by converting all their SAFEs, but most don’t. It ends up costing them dearly.*

That’s the history.

2024 – Today, pre-seed and seed rounds have evolved such that you very rarely see an equity round that is smaller than $3-5 million. Many companies raise more than $5-10 million as convertibles (SAFEs or Notes) before doing an equity round.

Given the current landscape and investor expectations, we typically advise founders to not swim too hard against the tide, but also not mindlessly drink the overly “standard” Kool-Aid. Yes, templates like the Post-Money SAFE have gained significant market share, but what you don’t hear as much in the (simplified) data is that they are still being negotiated, particularly on the anti-dilution economics issue discussed above.

Many founders are very uncomfortable with promising their SAFE holders anti-dilution for years, given how equity rounds have been pushed further into companies’ growth. Six years after the Post-Money SAFE’s release I still have not heard a logical argument for why if a startup successfully closes $X million as preferred stock, all prior investors get diluted (what normally happens), but if it happens to be a SAFE round (same valuation, same amount raised), no investors get diluted. Why is the paperwork structure of the round relevant to whether investors get diluted?

Many smart founders modify the Post-Money SAFE (lightly) to address the investor-biased anti-dilution issue. I posted a public redline for this years ago, available here, along with other info on the economic implications of making this modification. Changing just a few words in the Post-Money SAFE can, for a company that achieves at least a $100 million exit, amount to millions of dollars in the pockets of common stockholders (founders, employees) instead of VCs or accelerators. Anyone who thinks at least trying to make this change isn’t worth it, out of some fear of “friction” – isn’t (IMO) defending their cap table enough.

Remember that this modification still promises investors the cap table percentage that the post-money valuation cap implies. If they put in $1 million at a $10 million post-money cap they are getting 10% today, effectively. What the “fix” does, however, is ensure that 10% shrinks pro-rata if you do a new SAFE round in 6-12 months with a higher valuation cap. Because that’s what would happen if you’d raised that $1 million as an equity round instead, or as a convertible note or pre-money capped SAFE. This idea of promising non-dilution to SAFE investors was completely novel, unnecessary, and introduced by YC, costing founders a lot of money. 

Of the founders I observe actually trying to fix the Post-Money SAFEs problems, a material number (but not all) have it accepted by their investors. They send a simple markup early in the process, a little discussion happens, and investors either OK it or they don’t. It ultimately comes down to leverage, which no lawyer can change for you.

For founders unable or unwilling to push for this change, other possibilities are:

A. At a minimum understand the anti-dilution issue, and factor it into your modeling of subsequent rounds. View future SAFE dilution as stacked on top of what was previously given to SAFE investors. The earlier SAFE holders are not themselves being diluted, which means you (the founders) are being diluted more. Your valuation caps in future SAFE rounds thus need to be higher to account for the more aggressive founder dilution.

B. We’ve also seen some founders, instead of tweaking the Post-Money SAFE, simply switch back to an old school pre-money formula. I personally find this a bit awkward in the context of investor expectations of 2024, but it certainly happens sometimes.

C. Convert your SAFEs as soon as possible. This is the advice I give to YC founders, and the advice I give to anyone who has raised a substantial amount of money on unnegotiated Post-Money SAFEs. Cut the anti-dilution off as soon as you can by raising a seed equity round, even a small one. See my article Myths and Lies About Seed Equity Rounds to dispel any boogeyman stories you’ve heard about how equity shouldn’t be used until Series A.

Those stories are often driven by investors holding post-money SAFEs, who make way more money staying unconverted and therefore undiluted even as you raise more money and increase in valuation. Investors can be great sources of advice, but they are not your best friends. Cap tables are unavoidably a zero-sum game, and investors’ advice is very often designed to maximize the amount they get. Watch incentives.

Startup finance continues to evolve. Templates are useful as starting points of a negotiation. They’ve dramatically streamlined the earliest stages of funding, as the number of pre-seed and seed funds (and deals) has exploded. But be skeptical of anyone suggesting that those templates are never negotiable. They most certainly (often) are. The tiniest amount of negotiation can save you and your team millions of dollars. Don’t foolishly leave money on the table.

If you’re raising a pre-seed or seed round, feel free to reach out to us. We often do virtual office hours to help founders better understand these granularities as applied to their market context.

Post-script: After you’ve closed on Post-Money SAFEs, shrink your option pool to save on dilution. Having an unnecessarily large option pool before your SAFEs convert is just handing extra equity to your SAFE holders for no good reason.

*YC will not modify their own Post-Money SAFE for their cohort of accelerator companies. The only way to minimize the economic harshness of its terms is to raise a small equity round as soon as possible after YC to convert their SAFE. 

How Much Seed Rounds Cost – Lowering Fees and Expenses Safely

TL;DR: There are effective and efficient ways to lower your closing costs, in terms of legal fees and other expenses, for your seed round. But be mindful of the lean v. cheap distinction. A lot of founders myopically over-cut corners thinking that minimizing negotiation or deal structuring saves them money. This can easily cost 10-20x+ long-term in terms of economics (dilution) and governance power, because teams end up mindlessly signing terms against their interests. Thoughtful customization, combined with lean process and tools, gets you to a better outcome. Thinking lean – balancing flexibility, optimization, and efficiency – but not short-sightedly cheap, protects you from being penny wise but pound foolish.

Related reading:

There are two broad categories of costs for closing a seed round:

  • Legal Fees – Including whether you are using an incumbent “BigLaw” firm or a leaner boutique, and how you structure the round.
  • Post-Closing Expenses – Including state and securities filing fees, as well as 409A/cap table software costs

Seed Round Legal Fees

BigLaw v. Elite Boutique?

Without a doubt the two most significant drivers of legal fees are: (1) the type of law firm you are using, and (2) the round structure (contracts) you and your lead investors choose.  For a deep-dive on the “type of law firm” issue, see: Startup Legal Fee Cost Containment (Safely). In short, what has happened over the last decade or so is the incumbent Silicon Valley-based firms (BigLaw) have raised their pricing and grown so bloated (IMO) that they have simply overshot the needs of a huge segment of the startup ecosystem, especially at the earlier stages.

Granted, the market has historically not done a very good job of offering viable, credible alternatives to BigLaw in this space. What we’ve more often seen is (what I lovingly call) “shit firms” full of cheap but poorly-qualified lawyers, or peddlers of half-baked legal automation software that simply can’t handle the contextual nuances of high-growth companies. Lean but still elite boutique law firms, like Optimal (our firm), offer a more balanced package of highly-trained and credible professionals, including top-tier Partners, but lower costs derived from a more efficient firm operating structure.

To put this into more concrete numbers: a Partner in an incumbent “BigLaw” SV-based law firm will typically cost at least $900-1400 per hour, often more. At an elite lean boutique firm, the Partner will have an extremely similar background in terms of credentials, training, and experience, but be more like $450-650 per hour. Certainly not cheap – remember Partners don’t do most of the work in early-stage, they oversee things (quality control) and strategize with the C-suite and Board – but dramatically leaner than BigLaw. What allows leaner law firms to do this, while retaining top talent, is that they “burn” so much less money than firms built on traditional operating models. They can pay lawyers extremely well, but at lower rates.

Convertibles (Note or SAFE) v. Equity (Seed Equity or NVCA)?

The second big driver of legal fees in a seed round is the contract structure you and your investors use. Certain market players like to pretend as if this decision is very easy and simple, often because they make money nudging you in one direction, but it really is not that universal or clean cut.

Convertible instruments (convertible notes or SAFEs) are most certainly cheaper to close on and negotiate. Even within that category, however, there are key nuances. For example, whether there’s a valuation cap or not, whether that valuation cap is post-money v. pre-money, and of course whether you’re using convertible debt (notes) or SAFEs. Good reading on this: SAFEs v. Convertible Notes and A “Fix” for Post-Money SAFEs. These nuances can have enormously consequential (economically) impacts on a company.

While the big positive of convertible notes and SAFEs is speed and simplicity, their primary downside is uncertainty. They do not harden economics or governance rights the way that an equity round does, but instead deliberately punt on various hard questions to the future –  this is precisely how they simplify things. In many cases, this is a feature and not a bug, but not always. A huge number of startups are feeling these downsides in this heavy post-pandemic post-ZIRP economic downturn that the ecosystem is experiencing.

So many founders drank the “click click close” kool-aid suggesting that seed rounds are all “standard” and they should just sign YC’s default post-money SAFE. The main peddlers of this perspective were specific investors, who profited from pushing a contract structure designed for their economic interests, and automated financing companies who need you to not negotiate your deals, and believe it’s all “boilerplate,” so that you can let their software tool close everything for you. Obviously, automation software breaks down when confronted with any meaningful level of flexibility or structure nuance.

Now that these startup teams need to raise more money in hard times, they’re feeling the pain of having failed to do a bit more negotiation up-front, including by hardening investor economics when valuations were higher instead of simply relying on a moving valuation cap with no floor. The harsh anti-dilution mechanics of YC’s default SAFE are also imposing significant dilution on founders, whereas if they had just done a tad more thinking and structuring up-front they could’ve saved themselves potentially tens of millions of dollars worth of dilution. Losing millions in dilution in order to save a few thousand in fees is a perfect example of penny-wise, pound-foolish judgment.

See Myths about Seed Equity Rounds for a deep-dive into when equity, instead of a convertible, can make sense for your seed round. Choosing a simplified “seed equity” structure, instead of the longer, more complex NVCA-based equity deal contracts, can save tens of thousands in legal fees, and safely (without material hidden risks). You and your counsel will just need to get your investors comfortable with it, if possible.

Concrete Legal Fee Numbers:

If you’re using a lean elite boutique law firm, closing a convertible note or SAFE round is at most a few thousand dollars in legal fees ($2.5K-$5K). A little more if it’s heavily negotiated, but rarely more than $10K. BigLaw, with often double the rates, will naturally be more. This is for company-side costs. Investors usually pay their own fees in convertible rounds.

For simplified seed equity (not NVCA), a more typical range from a boutique law firm is $15K-$30K if we’re thinking of a 10%-90%-ile range, with below that range being zero negotiation super-fast closing, and above that range being when more heavy negotiation or cleanup diligence issues are involved. Again, BigLaw with its higher rates is probably twice that.

Some VCs will insist on structuring “seed rounds” in the exact same format as a Series A, using NVCA-based forms. This adds significant complexity and drafting time, as it’s a rejection of the simplified seed equity structure. For this structure, with a lean boutique a reasonable 10/90 range is $25K-$45K assuming the round is $4-6 million-ish raised. A larger round closer to $10M+ or higher may be closer to $50K due to more legal work demanded by the VCs, and will look more like a Series A. Again, BigLaw’s rates will drive that higher if you go that route. Often 2x. But importantly, a small minority of seed rounds are structured this way, as using this structure is more a response to a particular fund’s idiosyncratic preferences, and not some inherent necessity of seed financing.

Only perhaps 10-15% of these cost ranges boil down to what might be called “administrative” work – paralegal-esque mechanics like coordinating signatures, inputting numbers, etc. The real drivers are high-impact legal work of negotiation (including educating executives and Boards), structuring, drafting, and integration of the “code” (contract language) for the deal and planned corporate governance arrangement.

Sidenote to law firms: See Legal Tech for Startup Lawyers for some experienced advice on helpful software for reducing administrative time on financings. 

The key takeaway is how much seed rounds cost to close is heavily driven by the type of law firm you’re using, and the contract structure. My point here is not to pretend there is some formulaic, straightforward answer as to what any particular company should choose. It depends on context. My suggestion, however, is that founders actually act like executives and exercise some judgment – weighing the pros and cons, balancing flexibility v. speed, negotiation v. automation – instead of biting into X or Y peddler’s nonsense as to whatever a “standard” seed round looks like. We’re talking here about selling 10-30% of your cap table. Don’t be a myopic fool.

Other Seed Round Expenses

While not as meaningful as legal fees, there are a few other expenses that still impact the bottom line in a seed round. State filing fees, along with securities filings, can run you anywhere from $750-2,000 as a 10/90 range.

Carta or Pulley?

Higher than state or filing fees will be the cost of adopting capitalization table software and getting a 409A valuation; the latter of which is usually recommended if you intend to grant options after closing your round. Before a seed round, adopting any kind of cap table tool apart from MS Excel has always struck me as pointless. At under 10-20 cap table stakeholders, it’s not hard for a competent team, in collaboration with competent counsel, to maintain a spreadsheet. In fact, when very early founders introduce third-party cap table software into the mix, I sometimes see more mistakes, not fewer ones.

Historically, Carta has been the big incumbent player in this space, and deservedly so. But as is the case with many incumbents, there are growing concerns in the market about feature creep and excessive (rising) pricing. Sentiments like:

A big concern among law firms and VCs has been that no other leaner alternatives seemed to be gaining sufficient market share to counteract the network effect advantages that Carta has. But from what we’ve been observing, Pulley (Founders Fund Series B-funded) appears to be reaching a threshold where, at a minimum, founders need to be aware of them as a significantly less costly and simpler cap table + 409A option to the tune of thousands of dollars per year. Most serious law firms in this space are growing comfortable and familiar with it. Its simpler, more focused interface is certainly helpful.

We also published The Open Startup Model for founders who (understandably) want to avoid the cost of a third-party capitalization tool entirely until later in their company’s trajectory. A lot of lean companies get by just fine during seed stage, and sometimes even Series A, relying on a simple but well-organized excel model.

Summary

All smart founding teams are rightfully concerned about not over-spending to close their seed funding. But there’s a lot of opaque, and sometimes patently false, information available in the market as various commentators “talk their book” instead of laying out all the factors honestly.

On legal fees, law firm type and deal structure are big drivers. For the former, it’s BigLaw v. elite boutique. For the latter, the decision matrix is multi-variate. If convertibles: SAFE or Note, and within those categories, type of valuation cap. If equity: simplified seed equity or NVCA. Where you land on deal structure has millions of dollars in implications long-term. Take the time to exercise real judgment on this issue. Remember: lean, not cheap.

On post-closing cap tables and 409As, Carta is the quite expensive but solid incumbent, and Pulley is the increasingly attractive lean alternative. Assess both. Also consider just leaning on an Excel-based cap model.

Good luck.

Post-Money Valuation Cap Convertible Note Template

Link: Post-Money Valuation Capped Convertible Note Template

See also: Seed Round Template Library

Post-money (as opposed to conventional pre-money) valuation caps have become more of a thing in early-stage startup convertible rounds. The primary benefit of a post-money cap is that it makes it clearer to investors what percentage of the cap table they are purchasing as of the day of their investment, because the “all-inclusive” valuation cap incorporates all SAFEs and/or Notes the company has raised, even if they haven’t been formally converted or modeled on the cap table. In pre-money caps, what you are buying is more ambiguous.

The extra transparency of post-money caps can be a very good thing. But as I’ve written before, and many others have pointed out, the default post-money SAFE that YC published a few years ago had a very anti-founder “gotcha” built into it. Not only did it commit to a specific % of the cap table today, but it also gave investors aggressive anti-dilution protection for any future dilution from more SAFES or Notes, all the way until an equity round in which everything converts. Tons of companies have gotten burned by this, not understanding that YC’s Post-Money SAFE structure forces the common stock alone to absorb all dilution until SAFEs convert. This is way worse economically than other financing structures for early-stage.

Frankly, YC’s decision to make its SAFE instrument so investor friendly was surprising, even acknowledging that they, as investors, surely have benefited financially from it. Giving post-closing anti-dilution protection to SAFE investors isn’t necessary at all to give them the real primary benefit of a post-money cap, which is clarity as to what they are buying today. If I’m investing into a company that already has raised some SAFEs or Notes, I surely would like a hardened commitment as to what post-money valuation I’m paying for today, but I don’t see why I should expect protection from future dilution. For that reason, we published a “fixed” post-money SAFE template. With a few added words (clearly reflected in track changes for transparency), it “fixes” this anti-dilution problem in the YC template.

Acknowledging the benefits of even a “fixed” post-money SAFE, the truth is a lot of investors around the world, and in the U.S., still aren’t comfortable with SAFEs. They think SAFEs generally skimp too much on investor protection. For example, particularly in a down market like today, some investors would prefer the debt treatment of a convertible note. Even in 2023, we still see quite a few deals closed on convertible notes instead of SAFEs. I represent exactly zero VCs or tech investors, and what I’ll say on this topic is that in reality the differences between SAFEs and Notes are not super material; and never worth losing funding over them. Go with whatever works, and just make sure you have good advisors to protect you on more material points.

Most convertible notes I see today still use the older-style of pre-money valuation cap. There’s no reason why founders, in choosing to raise on a convertible note, should be stuck only with pre-money valuation caps, given that, as I described above, there can be very good reasons for using a post-money structure.

For that reason, I’ve taken the convertible note template that’s historically been publicly available here on SHL, and made a post-money valuation cap version. The benefits of a post-money valuation cap’s clarity, but under a convertible note structure. Just one more potential template to leverage in closing an early-stage round. Importantly, it does not have YC’s harsh anti-dilution mechanisms built in. The purpose of this post-money cap is to reassure investors as to what they are investing in today. There is no promise of anti-dilution for future fundraises because, in my opinion, there shouldn’t be.

The usual disclaimers apply here. This is just a template, and it is intended for use with experienced counsel. I am not recommending that founders use this template on their own without experienced advisors. If you choose to do so, do not blame me for any negative consequences.

Related recommended reading: Myths and Lies about Seed Equity. As useful as SAFEs and Convertible Notes are for simple early-stage fundraising, my impression is that they tend to get over-used, sometimes in contexts when an equity round really makes a lot more sense. Make sure you understand the full pros and cons of an equity round, including potential “seed equity” structures that are simpler and cheaper to close than full “NVCA” equity docs. A lot of the over-use of Notes and SAFEs stems from myths and falsehoods often shared in the market about equity deals.