Questions about SAFE Notes for a Startup

Quick VC questions for you banker folks - I'm building a startup and was told I need to leave my job and go start raising capital for my business. It's been a while since I've done anything VC-finance related so just wondering if someone can help me out here. 

We're a pre-revenue company, and I was told we should go aim for a seed stage raise with a $10MM-$20MM valuation cap.

  1. Does this give us a theoretical company valuation right now even if we don't have any customers/visitors to our tech platform yet? 
  2. When an investor provides us with SAFE Financing, what happens if we never go on to raise another financing? Since the investor's only "asset" is the right to invest at the lower of the valuation cap or the pre-money valuation in the subsequent round, what happens if the founding team chooses not to have a subsequent financing round and just fund the business from ongoing cashflows permanently? 
  3. If you start fundraising at the seed stage - are you basically pigeonholed to have to continue to keep doing equity raises until as the founder you basically have some stupid small amount of equity left like 20%? 
  4. Do you all buy into this "raise > invest in operations to improve sales / ignore bottom line > raise > repeat" cycle in Silicon Valley? While your ownership % will go down drastically, people keep telling me that the value of my shares will rise - but isn't this only based on a super bull tech market? At some point the real value has to be the claim to the operating cash flows am I right? 
  5. Should I focus on growing slowly using only my own resources (savings from my paycheques at work) to grow my startup and keep my 50% equity or should I sell my soul to Silicon Valley and go raise money on my first startup and go down that road? 


Comments (9)

Most Helpful
Nov 17, 2021 - 9:40pm

Have done a few of these, so my $0.02

  1. Not really, and that's the whole point. SAFE investors are basically saying that no one knows what your startup is worth, but when someone does we (the SAFE investors) will be rewarded for coming in before them.
  2. Highly unlikely. SAFE notes are often in the six, if not five figures. There are companies that bootstrap their way to scale (or get there on a sliver of outside financing) but they are very rare, and that happens to you it's going to be a very high class problem for your investors. They'll have a meaningful, undiluted position worth multiples of their $. 
  3. No. No one can force you to raise $, and no one will want the dilution unless there's a compelling use of proceeds. And if you end up with 20% when you get liquid, that's actually pretty good...
  4. If you figure this out you'll be the smartest person in Silicon Valley. 
  5. Use your savings to get some mockups and/or a responsive prototype together, and bring that to a few potential customers, not investors. See if one will prepay / pilot, or at least agree to be a pilot customer / partner. If they'll pay you it's the world's cheapest financing. But even if they won't, your odds of a successful raise will increase meaningfully if you can say you have one or more customers waiting in the wings.
  • Analyst 2 in IB - CB
Nov 17, 2021 - 10:29pm

Thanks for the detailed response!

On Point 5) - we're a consumer oriented startup (skill-gaming platform vertical) so pilot customers would need to come in large masses for us to start generating meaningful revenue. We were told by an investor that if we decide to launch now on our bootstrapped resources, if the initial traction doesn't go our way, it'll be significantly more difficult to raise. On the other hand, if we raise ahead of our launch (we already have a Version 1 of our website 90% done), then we can "sell the launch" to the investors. What are your thoughts, does this change your answer? 

Nov 18, 2021 - 9:41pm

It kind of depends on how much $ you and your cofounder(s) have, and how replaceable it is. The further you can get without outside financing, the better (obviously) but I'd spend only as much as you need to have some good KPIs, then raise. You'll have better odds of success, and a better valuation. But raise only what you need for max 24 months of runway, and be even keeled about the valuation. The higher it is, the harder it's going to be to raise the next one, if there is a next one.

Nov 18, 2021 - 12:54am

TBH, $10-20m valuation cap is pretty high for pre-rev, but you didn't describe other traction you might have - seems like you dont have any users as you haven't launched yet so comment holds.

While its nice to not dilute as much, the benefits right now of raising a smaller amount on a lower valuation (say 5-7m) are tactical: you'll reduce the risk of a down round later on. $10-20mm needs to be supported a bit more and if you can't justify it, especially post launch, you're in for a rough time trying to keep momentum.

Raise a little now at a lower valuation to get to the next milestone, then raise more at a better valuation when you can show a traction story.

  • Associate 1 in AM - Other
Nov 18, 2021 - 1:52am

In this market I wouldn't be surprised by a higher valuation. One of the founders of my firm likes to joke that a decent idea is worth $15 million in today's market, and if you are making money you might as well shoot for $30 million or more.

The great, sad, or scary thing (depending on your position) is that his joke isn't too far off from reality. 

  • Analyst 2 in IB - CB
Nov 18, 2021 - 11:11am

In this market I wouldn't be surprised by a higher valuation. One of the founders of my firm likes to joke that a decent idea is worth $15 million in today's market, and if you are making money you might as well shoot for $30 million or more.

The great, sad, or scary thing (depending on your position) is that his joke isn't too far off from reality. 

That seems to be kind of realistic.. most SAFE notes seem to have between a $2MM and $20MM valuation cap so I think that kind of says it all right there. 

This is my first startup though and it's basically my baby I don't want to lose all my ownership in it just for a faster scale-up, but the other side of me is dying to see traction/growth because I've been poor and working my ass off for a very long time and I'm ready to change the poor part.

  • Analyst 2 in IB - CB
Nov 18, 2021 - 11:09am

That's good feedback thanks! We spoke to a founder of a video game company and he said he did a SAFE at a $20MM cap with the only traction having been letting users play on weekends only a few times and not actually launching - with the intent of learning and getting feedback. 

Im thinking of us starting our platform the same way - weekends only for a little bit so we can say we haven't fully launched to investors but also we can see for ourselves if we'll have some of that initial traction we're seeking and gain valuable feedback from customers.

Nov 20, 2021 - 6:25am

1/ No in theory but in practice yes. Caps are a proxy for valuation in practice - because you have the right to convert at that price. 

2/ Many SAFEs come with a maturity date at which they convert (at least I always insert such a clause). Those kind of zombie companies do exist though, I'm an investor in 2 of those that chose to just turn profitable and continue their journey. I either write off the investment and give the shares back to founders (or get them to buy them back) or I just let them be until they get tired and want to exit.

3. No you do whatever you want as a majority owner. Maybe you see a huge growth opportunity and you need lots of cash to take advantage of that (doing the maths, the increase in the size of the potential exit would offset your dilution). Maybe you don't (but VCs most likely would not have invested in you if that was the case). Maybe you're so profitable you don't need money. (very unlikely but mailchimp was in this case).

4. Depends. Silicon Valley and 'the market' values growth. Regardless of cost structure. Most people think that profitability will eventually come at scale. At there are many reasons for this: you create a product that is habit forming, then you can increase prices once everybody is hooked on it. Or you become so big that you have a monopoly and huge pricing power. Or power over suppliers to increase your margins. Or cross-sell stuff, or reduce cost base through better tech and R&D etc. In some cases this does materialise, in other cases it doesn't but along the way I guarantee you that founders and VCs will have made money (at the expense of the post IPO investors).

5. My advice is : if you are not crystal clear about your product and pain you are tackling and who is going to buy it, keep iterating, build an MVP, test with clients, better - get some contracts. If you are super clear and believe that the potential is big - go raise money as fast as possible. Because others will come to the market and raising money is a competitive advantage where being first really matters.

  • Analyst 2 in IB - CB
Nov 20, 2021 - 1:10pm

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