Startup Fundraising FAQ

A SAFE (Simple Agreement for Future Equity) is an investment instrument created by Y Combinator that allows startups to raise capital quickly without immediately issuing shares or setting a valuation. When an investor signs a SAFE and provides funds, they receive the right to obtain equity in the company at a future "triggering event," typically a priced equity financing round. Unlike a loan, a SAFE has no maturity date, no interest rate, and no repayment obligation - if the company never raises a priced round, the SAFE may never convert (though SAFEs typically convert on acquisition or IPO as well).

SAFEs convert into preferred stock at either a discount to the price paid by new investors (typically 15-25%) or at a price based on a valuation cap, whichever gives the SAFE holder more shares. The valuation cap sets a maximum valuation for conversion purposes - if the company raises at a $20M valuation but the SAFE has a $10M cap, the SAFE converts as if the valuation were $10M. Modern "post-money" SAFEs (introduced in 2018) calculate the cap including all SAFE holders and the option pool, making dilution more predictable. SAFEs are standard for early-stage fundraising because they're simple, fast (often a 5-page document), and avoid the complexity of negotiating full equity terms before the company has meaningful traction. Use our SAFE conversion calculator to model your specific scenario.

Convertible notes and SAFEs both convert to equity at a future financing, but they differ in important structural ways. A convertible note is debt - it has a principal amount, accrues interest (typically 4-8% annually), and has a maturity date (usually 18-24 months) by which the company must repay or convert the note. The interest is typically added to the principal and converts to equity along with it. If the note reaches maturity without a qualifying financing, the investor can demand repayment, which gives them leverage to negotiate conversion terms or other remedies.

SAFEs are not debt - they have no interest, no maturity date, and no repayment obligation. This is simpler for companies but provides less protection for investors. Both instruments typically include valuation caps and/or discounts. Convertible notes may require promissory note filings and appear as debt on the balance sheet, while SAFEs are equity instruments. Some investors prefer convertible notes because the maturity date creates a forcing function, while others prefer SAFEs for their simplicity. From a founder perspective, SAFEs are generally more favorable because there's no debt overhang, no maturity deadline, and no interest accrual increasing the conversion amount over time.

A priced equity round is a financing where the company sells shares of preferred stock at a specific price per share, establishing a formal valuation for the company. Unlike SAFEs or convertible notes that defer valuation, priced rounds require negotiating detailed terms including the valuation (pre-money and post-money), liquidation preferences, anti-dilution provisions, board seats, protective provisions, information rights, and more. Priced rounds typically involve longer legal documents (stock purchase agreement, investor rights agreement, voting agreement, right of first refusal agreement, and amended charter), higher legal costs ($15,000-50,000+), and longer negotiation timelines.

Startups typically do priced rounds when raising Series A or later from institutional venture capital firms. VCs generally require priced rounds because they need the governance rights, board representation, and protections that come with preferred stock. Seed rounds were historically convertible notes but increasingly use SAFEs. The timing for a first priced round depends on: the amount being raised (larger amounts justify the complexity), investor requirements (institutional VCs typically require priced rounds), company stage (more traction supports a defensible valuation), and negotiating leverage (strong companies can push back on aggressive terms).

Dilution occurs when new shares are issued, reducing existing shareholders' percentage ownership of the company. Understanding dilution is crucial for founders and early employees. In a priced round, dilution is straightforward: if you own 50% of a company with 10 million shares, and the company issues 5 million new shares to investors, you now own 50% of 10M shares = 5M shares out of 15M total = 33.3% ownership. Your percentage decreased but your share count stayed the same.

With SAFEs and convertible notes, dilution is more complex because the instruments haven't converted yet. Post-money SAFEs make this clearer - a SAFE with a $5M post-money cap represents approximately $500K investment / $5M = 10% of the company at conversion, regardless of how much additional money is raised on SAFEs before conversion. Pre-money SAFEs and convertible notes convert based on the pre-money valuation of the next round, so more notes/SAFEs means more dilution for founders. Additional dilution comes from option pools - investors typically require expanding the option pool before their investment, diluting existing shareholders. Use our cap table calculator to model different scenarios and understand how various fundraising structures affect ownership. Founders should track both their percentage ownership and the absolute value of their stake (percentage times valuation).

A valuation cap sets a maximum company valuation at which a SAFE or convertible note will convert to equity, protecting early investors from excessive dilution if the company raises at a much higher valuation later. For example, if an investor puts $100K into a SAFE with a $5M cap, and the company later raises a Series A at a $20M pre-money valuation, the SAFE converts at the $5M cap, not $20M. The investor's $100K would buy shares as if the company were worth $5M, giving them 2% ownership ($100K/$5M) rather than 0.5% ($100K/$20M). The cap rewards early investors for taking risk before the company proved itself.

Valuation caps can be either pre-money or post-money. With a pre-money cap, the conversion calculation is: investment amount / valuation cap = ownership percentage, but this doesn't account for other SAFE holders. With a post-money cap (YC's current standard), the cap includes all SAFE holders and the option pool, so $100K on a $5M post-money cap always equals approximately 2% regardless of how much is raised on SAFEs. When setting caps, founders should consider: too low a cap gives away too much equity; too high a cap may not attract investors; and multiple rounds of SAFEs at escalating caps create a "SAFE stack" that can cause significant dilution at conversion.

A Series A term sheet outlines the key economic and governance terms for a priced equity round. Economic terms include: pre-money valuation (company value before investment), investment amount, price per share, liquidation preference (typically 1x non-participating, meaning investors get their money back before common shareholders in an exit), anti-dilution provisions (protecting investors if the company raises at a lower valuation), and dividends (usually non-cumulative and discretionary).

Governance terms include: board composition (often 2 founders, 1 investor, and sometimes 1-2 independents at Series A), protective provisions (investor veto rights over major decisions like selling the company, raising debt, or changing the charter), information rights (regular financial reporting), and registration rights (ability to participate in an IPO). Other key terms include: option pool (usually 10-20% set aside for employee equity, typically expanded pre-investment), pro-rata rights (investor right to maintain ownership percentage in future rounds), right of first refusal (company right to purchase shares before they're sold to third parties), and drag-along rights (ability to force all shareholders to participate in an acquisition). No-shop provisions prevent the company from soliciting other investors during negotiation. Understanding these terms is essential before signing.

An option pool is a percentage of company shares reserved for future equity grants to employees, advisors, and sometimes consultants. Investors typically require companies to establish or expand the option pool before their investment, and this pool is usually factored into the pre-money valuation, meaning existing shareholders (primarily founders) bear the dilution. For example, if a company has a $10M pre-money valuation and investors require a 15% option pool, and the current pool is 5%, the company must create 10% more shares for the pool before the investment. This effectively reduces the true pre-money valuation for founders.

The "option pool shuffle" is a negotiation point - larger pools dilute founders more but give the company more equity to attract talent; smaller pools may require renegotiation sooner. Typical option pools at Series A are 15-20%, though this varies by stage and hiring plans. When evaluating term sheets, calculate the "effective valuation" after option pool expansion. If you're given a $10M pre-money with a 20% option pool requirement, but currently have 10%, you're really getting roughly a $9M valuation on your existing shares. Use our cap table calculator to model option pool scenarios and understand the impact on founder ownership.

Startup fundraising in the United States must comply with federal securities laws, but several exemptions allow companies to raise capital without full SEC registration. Regulation D Rule 506(b) is the most common exemption for venture financing - it allows unlimited fundraising from accredited investors (individuals with $200K+ income or $1M+ net worth excluding primary residence, or entities with $5M+ assets) plus up to 35 sophisticated non-accredited investors. No general solicitation or advertising is allowed, and Form D must be filed with the SEC within 15 days of first sale.

Rule 506(c) permits general solicitation but requires verification that all investors are accredited. Regulation Crowdfunding (Reg CF) allows companies to raise up to $5 million annually from anyone through registered platforms, with disclosure requirements and investment limits based on investor income. Regulation A+ allows up to $75 million in offerings with SEC qualification, sometimes called a "mini-IPO." State blue sky laws also apply - Rule 506 offerings are preempted from state registration but may require notice filings. California Section 25102(f) is commonly used for sales to company insiders. Violations of securities laws can void transactions and create personal liability for founders. Most startup counsel handle these filings routinely, but founders should understand the applicable exemptions and compliance requirements.