SAFEs and Convertible Notes

How to model convertible notes, premoney SAFEs, and postmoney SAFEs in the Cap Table and Exit Waterfall Tool

Raising money via convertibles

Convertible notes and SAFEs don't give holders shares yet. They give the right to buy shares later, at a price the priced round will set. They convert into equity when that round closes, usually at a different price than the new equity pays.

How to handle unconverted convertibles in a liquidity event: Unconverted Convertibles

Who bears the dilution

The key question in a conversion: who bears the dilution from issuing new shares to convertible holders?

All shareholders, including new equity investors in the round
Existing shareholders only
Some mix of the two

Legal documents specify how share prices are calculated and how share classes are treated.

The general formula:

Premoney valuation / (Fully-Diluted Shares prior to the round + dilutive shares included in the calculation)

Premoney is the agreed value of the company before the round.

Money raised via convertibles is not added to the premoney or the round amount. That capital is already in the company's bank, or already spent, and it's reflected in the premoney.

The share count used in the denominator is what matters, and it varies by instrument and by what the legal docs specify.

Issuing new equity:

Fully-diluted shares prior to the round
If investor-friendly: shares issued through all premoney SAFEs and convertible notes
If converting a postmoney SAFE: all shares issued to postmoney SAFEs
If investor-friendly: new options issued through creating or expanding the pool
If anti-dilution triggers: as-converted shares added to existing shareholders

Converting postmoney SAFEs:

Fully-diluted shares prior to the round
All shares issued through converting postmoney SAFEs and other convertibles

Converting premoney SAFEs and convertible notes:

Fully-diluted shares prior to the round
New options from pool expansion

Fully diluted = issued and outstanding + currently authorized options.

When the company bears the dilution from a conversion, you include those converted shares in the denominator. That pulls down the share price for new equity, and with it the real valuation the company is getting.

Effective premoney = negotiated premoney minus the value of the dilution borne by existing shareholders.

A worked example. Premoney is $5mm, there are 10mm fully-diluted shares before the round, and a $500k postmoney SAFE with a 20% discount and no cap is converting.

Because the SAFE buys in at a 20% discount, its $500k is worth more than $500k of new equity. At the round price it's worth $500k / (1 - 20%) = $625k. If the company bears that dilution, it's effectively raising on a $5mm - $625k = $4.375mm premoney.

There are two ways to get to the share price, and they agree:

Effective premoney: ($5mm - $500k / (1 - 20%)) / 10mm = $0.4375 per share

Adjusted denominator: $5mm / (10mm + $500k / (Price per share * (1 - 20%))) = $0.4375 per share

The first matches how legal documents specify the calculation, so it's the clearer one to apply. The second is circular, which is fine. Turn on iterative calculations and let it solve.

Conversion is a negotiation on dilution

How a convertible converts is a negotiation over who absorbs its dilution, and it should be settled alongside the valuation, not after it.

Take a $3mm new investment at a $17mm premoney with $2mm of unconverted convertibles. From the new investor's angle, the same deal produces two different outcomes:

Postmoney conversion: $3mm / ($3mm + $17mm) = 15%
Premoney conversion: $3mm / ($3mm + $17mm + $2mm) = 13.6%

The investor expecting 15% and the founder expecting to give up 13.6% can both be satisfied by moving the premoney. At a $15mm premoney, the premoney conversion gets the investor back to 15%:

$3mm / ($3mm + $15mm + $2mm) = 15%

The conversion method and the valuation are one negotiation, not two.

Postmoney SAFE conversion

Treat postmoney SAFEs as converting first, before the equity round, using the cap or discount.

Mental model: "convert the SAFEs, then issue the equity."

Dilution from SAFEs is borne entirely by existing shareholders (typically founders and management holding common).

Premoney SAFE and convertible note conversion

Treat these as converting at the same time as the equity issuance. Three methods:

Premoney method (a postmoney conversion), the "founder-friendly" option
Percentage Ownership method, also called the postmoney method (a premoney conversion), the "investor-friendly" option
Dollars Invested method, an in-between

The differences are about who bears the dilution and how much.

Premoney SAFEs and convertible notes use the same conversion math; they differ mostly in legal treatment. Two things to watch on notes:

Payment or conversion without a qualified financing. At exit or at maturity, how's the note handled? SAFEs don't have maturity, so this is a note-specific issue. Notes typically pay out at a multiple of outstanding principal (plus accrued interest).
Converting interest. Usually accrued and added to the balance at conversion.

Example convertible note with seed-stage conversion terms: Fenwick.

Premoney method, "founder-friendly"

Price per share of the new equity is calculated using fully-diluted shares prior to the round, then the convertibles' share price is calculated.

Dilution from the convertibles spreads across existing and new investors, so the new investor ends up with less than they expected.

Example: invest $1mm at $10mm postmoney expecting 10%. After convertibles convert, you get < 10%.

Percentage Ownership method, "investor-friendly"

Price per share is premoney valuation divided by fully diluted shares prior to the round + shares issued to convertibles converting in the round.

Dilution falls entirely on existing investors. New investor gets what they expected.

Equivalent shortcut: calculate the full dilutive value of the convertibles and subtract from negotiated premoney to get the effective premoney.

Dollars Invested method

Price per share is premoney valuation divided by issued and outstanding + shares issued to convertibles from the conversion discount only.

Splits the dilution between existing and new investors. Accounts separately for dilution from the money invested in the convertibles (borne by all) and dilution from the discount (borne by existing).

Shortcut: calculate the dilutive value of the conversion discount and subtract from negotiated premoney.

Reference: Calculating Share Prices with Outstanding Convertible Notes or SAFEs.

What conversion produces on the cap table

A common mistake: treat the round as a single class of preferred (Series A) and lump all converted SAFEs and notes into it at the new equity price. That works for ownership math but breaks liquidation preferences in the waterfall.

When SAFEs and notes converted at different prices, each conversion gets its own preferred subseries on the post-round cap table.

Series A-1 for the new equity at the round price
Series A-2, A-3, A-4 for each batch of SAFEs and notes that converted at a different price (one cap, one discount, one note)

All subseries are pari passu within the round (equal seniority among each other) but their liquidation preferences are sized to the dollars actually invested by each holder, not to converted-share-count multiplied by the new round price. Otherwise a SAFE holder who invested $250k at a $5m cap would end up with a preference based on the $1mm-plus value of their converted shares, which is a windfall the legal docs do not grant.

The same logic applies to converting notes that include accrued interest: the preference attaches to principal plus interest, not to the share count post-conversion.

Practical implication: when modeling a round in the Cap Table and Exit Waterfall Tool, break the converting securities into rows by cap or discount, label each as A-1, A-2, A-3, and link each row's liquidation preference to the original purchase amount, not to share count times new equity price.

Founder-friendly vs investor-friendly

The premoney/postmoney terminology is confusing, and honestly a little exclusionary. I don't think in those terms. I think about who bears the dilution: investor-friendly or founder-friendly. That's the question that actually changes the cap table.

For premoney SAFEs, premoney conversion is the common default, which puts the dilution on existing shareholders.

You won't see any of these method names in a legal document. What you'll see is a definition of which shares are included in the SAFE price calculation, and that definition is what drives the dilution. Always read the legal docs. Templates get modified more often than people expect.

Terms to look for in legal docs

When you open a SAFE or note, these are the defined terms that carry the math:

Purchase Amount. The amount invested by the SAFE holder.
Standard Preferred Stock. The stock issued to the new equity investor when the SAFE converts.
Safe Preferred Stock. The stock issued to SAFE holders on conversion, typically with the same rights as Standard Preferred but different liquidation preferences.
Safe Price. With a valuation cap, the price paid for SAFE Preferred, typically Valuation Cap / Company Capitalization.
Discount Price. With a discount rate, the price per share paid for SAFE Preferred.
Company Capitalization. How to count the shares used in the share-price calculation.
Equity Financing Event. How the SAFE converts, usually the greater of (1) Purchase Amount / lowest Standard Preferred price, (2, if applicable) Purchase Amount / Safe Price, or (3, if applicable) Purchase Amount / Discount Price.

Of these, Company Capitalization is the one to read closely. It defines the denominator in the share-price calculation, and the denominator is what decides who gets diluted. The wording varies between documents, and a small change to it moves real ownership. Find that definition and you've found how the conversion works.

Glossary

Term	Definition
Converting Investments	Convertibles convert to equity when a priced round is raised, at a different price
Percentage Ownership	Shares owned / fully-diluted shares
Effective Premoney Valuation	Premoney minus the value of dilution borne by existing shareholders
Convertible Note	Debt that converts to equity at a milestone. Has discount, cap, interest rate, and maturity
Premoney SAFE	Warrant-like, not debt. Simpler docs, standardized. Can have cap or discount. No interest, no maturity. Introduced by Y Combinator in 2013
Postmoney SAFE	Introduced by Y Combinator in 2018. Defines the exact conversion method, adding anti-dilution for investors. Removed prorata by default (side letter available)
Valuation Cap	Understanding the valuation cap
Discount Rate	Discount applied to the new equity price when pricing convertibles. Check whether docs express this as (1 - discount) or (discount) * price
Interest Rate	Convertible note interest rates
Investor Friendly	Dilution from convertibles borne entirely by existing shareholders
Founder Friendly	Dilution borne by all shareholders including new investors
Premoney Method	Founder-friendly. The equity price uses fully-diluted shares prior to the round, so dilution from the convertibles spreads across new and existing investors. Also called a postmoney conversion, or "convert in the postmoney"
Percentage Ownership Method	Investor-friendly. The equity price puts the converting shares in the denominator, so dilution falls on existing shareholders. Also called the postmoney method, a premoney conversion, or "convert in the premoney". See Cooley
Dollars Invested Method	An in-between. Only the discount-driven shares go in the denominator. See Cooley