#BuildingforBella: Part 8- A quick glance into Priced Rounds and SAFE Rounds
March 12, 2024
Gearing for a pre-seed round as an aspiring founder? It’s key to understand the fundamentals of valuations. In this article, we will look into the concepts of Priced Rounds and SAFE Rounds as well as provide insights into the opportunities and challenges that are peculiar to African fintech pre-seed founders.
Priced Rounds
Priced rounds are a structured fundraising approach that startups use to secure capital from investors. In a priced round, the founders and the investors agree on a specific valuation of the company. The valuation considers several factors such as the market potential, the innovation, product user acquisition, the team and several factors. The investors usually do an analysis of the market size, the competition and the environment of operation as well as take a deep dive into the strategies being used to acquire and retain users for your product. This gives credibility to your potential for growth. Your product also shows viability through innovation and the ability to disrupt current services. All these factors serve as a determiner to calculate the equity stake that investors will receive in exchange for their investment.
Elements of a Priced Round
As a fintech founder, several elements come into play when gearing for a priced round. Some of them are:
Valuation: This is the most crucial element as it influences the amount of equity that you will need to offer to investors in exchange for capital. A pre-money valuation is the estimated value of the company before receiving investment while a post-money valuation is the value of the company after investment has been received.
Due Diligence: The investors will usually carry out a due diligence on your company hence you will need to provide accurate documentation to guide their process.
Negotiation: Here, founders and investors negotiate to arrive at a mutually agreeable term.
Investment amount: This is often determined based on your startup’s current needs.
Equity offer: This is determined upon the valuation and it serves as a representation of ownership stake in the startup by the investors.
Term sheet: This is a non-binding document that outlines the terms and conditions of the investment.
Rights & Protections: This specifies special rights or investor protections for their investment in the company.
Use of funds: This clarifies how the funds will be utilized in terms of specificity.
Legal Documentation: This includes legal documents such as shareholder agreements, certificates and more.
Closing Conditions: This outlines the specific conditions that need to be met before declaring a round as closed.
SAFE Rounds
Unlike priced rounds, a SAFE round is a more flexible approach. SAFE stands for "Simple Agreement for Future Equity," and is basically a financial instrument that enables startups to raise capital without any immediate valuation. With a SAFE, the valuation can be postponed to a later stage allowing the startup to focus on building their product and user base with little pressure while investors who express confidence in your venture are focused on a potential for future equity in the company. In simple terms, at the time of issuance, a SAFE isn’t a direct equity investment but more of a promise of potential future equity.
Elements of a SAFE Round
Valuation Cap: This is a pre-determined maximum valuation at which the investment will convert into equity during a future priced round.
Discount Rate: This is a percentage that allows an investor to purchase equity at a lower price than future investors during a priced round.
Conversion Trigger: This is an event that initiates the conversion of the SAFE into equity. For example; a future equity financing round, an acquisition and an initial public offering (IPO).
Maturity Date: This is the deadline that the SAFE must convert into equity. If the trigger event has not occurred by this date, the investor may have the option to convert the SAFE into equity or receive their investment back with agreed-upon interest.
Investment Amount: This is the total amount of investment being provided as specified in the SAFE.
Dilution Protection: This is included in the SAFE to protect early investors from dilution in subsequent rounds.
Compliance: This is usually a governing law and jurisdiction clause that specifies the legal framework under which the SAFE is governed and any jurisdictional considerations in case of disputes.
Representations and Warranties: These are statements made by the startup about its current status, operations, and legal standing to provide transparency and mitigate risks for investors.
Amendment and Waiver: This clause outlines the conditions that the SAFE terms can be modified and whether certain provisions can be waived.
Closing Conditions: These are conditions that must be met before the SAFE round is officially closed.
Key things to consider for each funding method
Valuation Challenges: In a priced round, determining a fair and accurate valuation for an early-stage startup can be somewhat challenging. Founders need to prepare comprehensive data while investors also need to be fair with their negotiation strategy. On the other hand, a deferred valuation for SAFE rounds can lead to uncertainty of future dilution, hence startup founders need to have an adequate understanding of the level of transparency required to engage in long-term relationships as well as ensure that conversion terms are favourable enough for both the founders and the investors.
Legal and compliance: Both methods require adequate compliance with legal and regulatory requirements in the operational environments. Founders need to ensure that they have quality legal counsel to help avoid future issues.
Exit strategy: As a founder, it’s important to consider the long-term implications of the funding method chosen and its impact on your existing strategy. Ensure that the method you choose aligns favourably with your startup growth plan and potential industry exit.
In general, deciding to choose either of these financial instruments heavily depends on the specific needs and goals of the startups. As a founder, it’s important to engage in open and transparent discussions with your investors to ensure that you are aligned on the expectations and challenges specific to each funding method. While priced rounds offer structure, SAFE rounds provide flexibility. Do a thoughtful analysis, and get a great counsel to guide you through the journey.