How is the share price calculated when SAFEs or notes convert?
FundraisingValuationCap tableSAFEsConvertible notes
Without SAFEs or notes the price per share is simple: the pre-money valuation divided by the fully diluted shares outstanding, and a $2 million investment at an $8 million pre-money buys 20 percent. With SAFEs or notes converting at a discount or cap, new shares appear that nobody's math accounted for, and either the founders end up with less than 80 percent or the investors end up with less than 20. Which one depends on the method the term sheet names, usually in a sentence founders do not read. The pre-money method fixes the valuation and lets the conversion dilute everyone. The percentage-ownership method fixes the investors' stake and puts all the dilution on the founders. The dollars-invested method splits the difference by treating the converting money as new investment.
The example
Take an $8 million pre-money, a $2 million Series A, $1 million of SAFEs converting at a 30 percent discount, and 1 million fully diluted shares before the round. The three methods give three different prices, and each side has a reason to prefer one of them.
Pre-money method
The pre-money valuation is fixed and everything else follows. The Series A price is $8.00 a share, the SAFEs convert at $5.60, and the converting shares dilute the founders and the new investors alike. The founders end at 70 percent and the Series A at 17.5 percent rather than the 20 they thought they were buying. Founders like this method. New investors notice that their post-money is now $11.4 million and that they own less than the term sheet implied.
Percentage-ownership method
The investors' percentage is fixed at 20, or equivalently the post-money is fixed at $10 million, and the price is whatever makes that true. Here it is $6.57 a share, the SAFEs convert at $4.60, and every share the SAFE holders receive comes out of the founders, who end at 65.7 percent. The effective pre-money has fallen to $6.57 million. This is the method a term sheet is using when it says the pre-money valuation is inclusive of, or fully diluted for, all converting securities. Investors like it because they get the percentage they priced.
Dollars-invested method
The compromise. The post-money is fixed at the pre-money plus the new money plus the SAFE or note principal, here $11 million, and the price follows: $7.57 a share for the Series A, $5.30 for the SAFEs. The converting money is treated as if it were new investment, so the investors are not diluted by the principal, and only the extra shares the discount produces dilute the founders, who end at 68.8 percent. The logic is that converting a dollar of SAFE at full price does not change what the investors bargained for; only the discount does.
Under a post-money SAFE the arithmetic is settled before any of this: each SAFE holder's percentage is fixed by their cap, and the SAFE's own terms put that dilution on the founders. The three methods above still decide how the round's new shares are priced around them. Whichever way the numbers fall, the lesson is the same: agree the method, in writing, in the term sheet, because the price per share is a second valuation negotiation and it is better to have it before the lawyers are drafting than after.
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Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.