TBC: Revisiting Post-Money vs Pre-Money Cap SAFEs

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Hey there. Welcome to another episode of the back channel. If you've been following along in the last few weeks, we've been dropping episodes about post-money valuation caps. I gave a little bit of an explained around how valuation caps work, because someone had asked me a question about it. And it led me to want to talk about uncapped safes. And then I was like, oh man, we should really talk again about post-money capsaicin, how they have anti dilution.

Well, it turns out one of our earliest episodes of the back channel. I had forgotten that I had done my own explainer on how. Postmate cap saves have anti-dilution and why founders should worry about that and how they should defend against it. So instead of going through. Another full [00:01:00] repeat description of that. I just wanted to record this intro to my previous episode on postman, EnCap, safes, and how they have anti dilution.

So we'll roll right into the recording from that episode way back in, I don't know, last year, sometime. Uh, but I hope that content is really helpful for you and that you get a better sense for why you need to be careful around post-money cap safes.

All right. Enjoy.

In today's episode, we're going to start diving into some of the dynamics of the post-money cap safe. This is something that I really take pride in illuminating for founders, because I think it's a uh, vehicle, it's a security that founders don't quite understand. And there's some gotchas in there that make lives a little bit more difficult for founders impact their ownership and it's things that founders don't quite know right from the get go. So before we get into some of the more detailed intricacies of how those instruments work, one of the first things we have to [00:02:00] understand is what a post-money cap even means. We can talk about post-money caps versus pre money caps. It's also relevant to talk about . It in the idea of post-money valuations in pre money valuations.

Now, anytime you're talking about post-money and pre money. You're talking about the valuation of the company before new capital comes in and after new capital comes in. So an easy example would be to say, What is your company worth today? Right now, before we do anything else?

Let's say it's worth $5 million. That would be the pre money valuation, that is the valuation of the company before any investment comes in. Now, if you were to raise $1 million on that company that is today worth $5 million. You would have a company worth $5 million and it would be adding $1 million of cash onto that company.

So, [00:03:00] what is the company worth after that? Five plus one? It's $6 million. And that would be the post money valuation. . So what is the valuation of the company post injection of money? So that's pre-money and post-money valuations. Now, when we think about caps, it's the same effective thing we're talking about. What is the valuation that the investor will convert at?

Without getting into too many details. We can effectively think about it as a type of valuation. And so when we think about pre money caps and post-money caps, You're trying to decide how you manage the fundraise of your company.

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Prior to 2018, when we looked at things like convertible notes or safes.

The common way to value those safes was with pre money [00:05:00] caps. In 2018, YC changed the standard that they were using on safes to a post-money cap safe. Now, what does that mean? That means if you were raising money at a post money of 10, that means we are fixing the value of the company after money comes in to $10 million.

That means if I raise $2 million into your company at a $10 million post, how do we figure out what they're saying your company is worth today? Well, you take that 10 and you subtract the two because you want to understand what is the valuation

pre the money coming in. So 10 minus $2 million is an $8 million pre money valuation. A $10 million post-money cap raising $2 million is effectively saying the company is worth $8 million. 10 minus two equals eight.

Now [00:06:00] here's where the trickiness of . Post-money caps and pre-money caps come into play. Pre-money caps were always thought of as slightly more complicated. It was confusing for some founders. They were like, how much do I own? How much is an investor buying? If I have a, you know, pre-money valuation of eight and raising two, one of my actually worth people didn't realize the math was well. The two.

Divided by eight plus two equals 10. So two divided by 10. It goes 20%. That's what the investor is buying. The post-money cap made it. The headline was that it makes it easier to calculate. Whenever you see the post-money valuation. You just divided that by the number of dollars raise. So.

$12 million post cap raising three, three divided by 12. $20 million post-money cap raising $5 million, it's five divided by 20. That's the ownership percentage. It became very easy. But the [00:07:00] thing you have to understand is that that post money cap is fixed. Meaning if you say you want to go raise.

A million dollars on a $10 million post-money cap. What you're saying is you want to sell 10% of your company. One divided by 10. You're saying that your company today is essentially worth $9 million. But if along the way of trying to raise money, investors are like, excited about what you do. And they want to raise, they want to jump into that fundraiser as well. They want to jump into that round

And instead of raising $1 million, there's $2 million of demand and you want to raise $2 million instead, but you're still at that $10 million post-money cap, what effectively has happened is you value your company even lower. So instead of 10 minus one equals $9 million is what you're worth today.

It's $10 million minus two. You're saying you're worth $8 [00:08:00] million. So the more money that's raised on a post-money cap,

The lower your effective valuation goes. this is one of the dynamics of post-money caps that I think founders don't understand. And while the math is easy,

and pre-money cap safes and post-money cap safes are the same as long as you go communicate how much you want to raise and you stick to how much you want to raise. And both investors and founders are in lock step there, then it's exactly the same. But what I know, based on my experience as an investor, and a founder and advisor is that you rarely hit the number exactly where you want to be. And so just, this is not to say that you should do one thing or another. It's just to realize what is happening with a post-money cap as you raise more and more money. Okay. That's going to be our first conversation around post-money cap saves.

In future episodes of the back channel, we will be talking more [00:09:00] about the details of post money cap safes that I think are really important for founders to understand. that's this episode of the back channel. We'll see you next time.

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