SAFEs and Valuation Caps: 2023 Analysis
By Lior Ronen | Founder, Finro Financial Consulting
When you start a new company, one of the first big steps is getting money to help it grow.
There's a special way to do this called SAFEs, which stands for Simple Agreements for Future Equity.
Think of SAFEs as a promise that a new company makes to someone who gives them money. The promise is that later on, when the company is worth more, they'll turn that money into a share of the company.
In 2023, lots of new companies used SAFEs to get money. They didn't worry about how much their company was worth right away. Instead, they focused on getting the funds they needed to make their ideas come to life.
The analysis includes 15,000 deals that happen this way, and they tell us a lot about what kinds of new companies were popular and which ones people wanted to invest in. For example, companies that work with new internet technology and clean energy got a lot of attention and money from investors.
In this article, we will talk about how new companies got money last year using SAFEs.
We'll look at the different kinds of companies that did well and some that had a harder time. We'll also see how much money they got and where they are from. All of this helps us understand what's happening with new companies and where they might be going next.
So let's get started and take a closer look at how new companies got their start with SAFEs in 2023!
In 2023, startups embraced SAFEs as a flexible way to secure funding, with over 15,000 agreements signed, particularly favoring companies in tech hubs like California and New York. While sectors like Web3 and Renewable Energy saw substantial investments, indicating strong investor confidence, industries such as Apparel and Edtech faced declines. Overall, despite economic uncertainties, the consistency in pre-seed investments through SAFEs highlighted a robust early-stage venture ecosystem, underscoring the adaptability and enduring interest in innovative startups.
Understanding Valuation Caps and SAFEs
A valuation cap is like a promise between a new company and the people who invest in it.
It's a number that sets the highest value the company can have when the time comes to change the investors' initial support (given through a SAFE) into a share of the company.
This cap is like saying, "No matter how much the company is worth, we'll act like it's worth this amount or less when we give you your shares."
Key Points About Valuation Caps:
SAFEs can be made with or without a valuation cap. If a SAFE doesn't have a cap, there's no set limit on what the company might be worth when shares are given.
When a company gets more money in the future and sets a price for its shares (this is called a priced equity financing round), the SAFE turns into shares. If there's a valuation cap, and the company is worth more than this cap, investors get to pretend the company is only worth the capped amount. This is good for them because they get more for their money.
If the company's value goes up a lot after the SAFE but before it changes into shares, a valuation cap means the early investors get a better deal. They get more shares for less money than new investors who come in later.
Having a valuation cap can protect investors by making sure they get a nice benefit if the company does really well quickly.
So, What Does This All Mean?
A valuation cap sets a kind of fixed price on how much each share costs when an investor's SAFE turns into actual shares. It’s a way to reward early investors if the company's value skyrockets by the time they get their shares.
The State of Valuation Caps
Now that we have a clear understanding of what SAFEs and valuation caps are, let's examine their current state as of 2023. These caps are crucial as they significantly influence the portion of the company that investors will own when their SAFE investment converts into equity.
The data from 2023 presents a compelling narrative, not only reflecting the strategic decisions of individual companies but also capturing the broader economic shifts.
Valuation Caps: Different Places, Different Numbers
Last year, over 15,000 post-money SAFEs were signed, with a median post-money valuation cap of $10M across all industries—evidence of a dynamic startup funding arena. Additionally, startups secured a median of $660K through SAFEs, indicating robust activity at the pre-seed stage. These valuation caps are highly sensitive to the amount raised in a given SAFE round and the location of the startup.
In particular, startups based in California and New York showcased higher valuation caps across various SAFE round sizes. For example:
In SAFE rounds under $250K, the median valuation cap was $6M in CA & NY, as opposed to $5M outside these states.
For rounds ranging from $250K to $499K, the cap increased to $8M in CA & NY, compared to $6M elsewhere.
With larger rounds exceeding $5M, the trend persisted, with a median cap of $30M in CA & NY against $28M in other regions.
These statistics emphasize how geographical location influences valuation cap decisions, with CA & NY startups generally commanding higher caps, likely due to the more robust investment climate and competitive market in these regions.
To conclude, the 2023 landscape of SAFE agreements was marked by significant regional disparities, with startups in tech hubs like California and New York benefiting from higher valuation caps. This disparity reflects the dynamic nature of the startup ecosystem and the varying levels of investor confidence and market maturity across different regions.
As we progress through 2024, comprehending these nuances becomes increasingly crucial for founders and investors, empowering them to make well-informed decisions in a competitive and constantly evolving environment.
Impact of SAFE Round Sizes on Valuation Caps
The size of a SAFE round plays a pivotal role in determining the valuation caps, a trend that has become increasingly apparent in 2023.
This section dives into the relationship between the amount raised in a SAFE round and the resulting valuation cap, highlighting how this interplay shapes the equity landscape for startups and investors.
A clear pattern emerges when we analyze SAFE rounds of varying sizes: as the amount of money raised in a SAFE round increases, so does the valuation cap. This correlation suggests that investors are willing to accommodate higher caps in exchange for a stake in startups raising larger amounts, likely due to perceived potential or proven track record.
An intriguing aspect of this trend is the widening range of valuation caps as the round sizes increase. In smaller SAFE rounds, the range between the lower and upper percentiles (25th and 75th) is relatively narrow, indicating a consensus or standard in the valuation caps.
However, in larger rounds, this range expands significantly, suggesting greater variability and less predictability in the caps.
This widening range can be interpreted in several ways:
It may reflect a higher degree of negotiation and individual assessment for larger funding rounds, where the stakes and potential returns are higher.
It could indicate a diverse range of startup maturity and potential within these larger rounds, leading to more varied investor expectations and agreements.
Angel Investments, Check Sizes, and Their Impact Across SAFE Rounds
In the dynamic world of startup financing, angel investments and the size of checks they write play a crucial role, especially in the initial stages of a startup's lifecycle.
This section offers an in-depth look at the distribution of angel check sizes in pre-seed funding and how these trends evolve across different SAFE rounds.
Distribution and Significance of Angel Check Sizes in Pre-Seed Funding
Angel investors, often the lifeline for startups in their nascent stages, exhibit varied investment behaviors, especially in pre-seed funding. The check sizes range significantly, with smaller checks (below $50K) serving as the initial boost for startups to cover essential early costs like market research or product development.
These smaller investments are not just critical for startups but are also strategic for investors, allowing them to diversify their portfolios across different ventures. As the startups progress to larger SAFE rounds, the check sizes tend to increase, reflecting a growing confidence in the startup's potential and a deeper commitment from the investors.
Trends in Check Sizes Across Different SAFE Rounds
As startups mature and enter larger SAFE rounds, the check sizes from angel investors and other early backers typically grow. This increase is indicative of the startups' escalating needs and the escalating confidence from investors. For instance, while a typical check size in a pre-seed round might be around $25K, this number can climb significantly in later rounds, sometimes exceeding $100K.
This shift from smaller to larger checks is not just a function of the growing needs of the startup but also an indicator of the startup's growth and scalability. Larger check sizes in later rounds suggest a startup's evolving stature, demonstrating tangible progress and a higher degree of investor trust.
Median Check Sizes and Strategic Fundraising
Analyzing the median check sizes across various SAFE rounds reveals a nuanced picture of investor behavior and startup growth. In the early stages, median check sizes are relatively modest, but as startups demonstrate viability and growth potential, these median sizes increase. This trend underscores the importance of aligning fundraising strategies with the growth stage of the startup.
For startups, understanding this trajectory is crucial for effective fundraising planning. It helps in setting realistic expectations for investment amounts in different stages and strategizing on how to effectively use these funds to achieve key milestones.
SAFEs Fundraising Insights per Industry
As the startup ecosystem continues to evolve, the fundraising landscape reveals distinctive patterns across various industries. In this section, we examine the insights gleaned from industry trends in SAFE fundraising, highlighting how different sectors are capitalizing on these flexible financial instruments.
Web3: A Resilient Comeback
The Web3 sector, emerging from a period of skepticism, has demonstrated a strong resurgence. This industry stands out with a significant number of fundraising rounds and notably high median valuation caps. The prevalence of token-based funding models in Web3 contributes to this unique trend, reflecting a renewed investor interest and a distinct approach to valuing these futuristic companies.
Renewable Energy and Biotech: Indicators of Confidence
Both the Renewable Energy and Biotech sectors have shown remarkable performance, with above-average cash raised and valuation caps. These numbers are a testament to the investor confidence in these fields, acknowledging their strategic importance and long-term growth potential. The substantial investments in these sectors suggest a commitment to sustainable and innovative solutions that address pressing global challenges.
Standardization in Valuation Caps
A conspicuous trend across many industries is the convergence toward a $10M median valuation cap. This suggests a possible emerging norm or a lack of detailed precision in setting these caps, especially when compared to the more rigorous process of formal valuations during priced rounds. The adherence to this median figure may indicate an industry baseline that influences negotiation strategies and expectations.
Pharma and Medical Devices
The Hidden Giants Pharma and Medical Devices might appear as smaller entities within the SAFE landscape, but their impact is more substantial than at first glance. If convertible notes—a popular fundraising mechanism in these sectors—were considered, their presence would be significantly larger. This highlights the diversity of funding mechanisms leveraged by startups in these highly specialized and capital-intensive fields.
The Trend of Multi-Round Fundraising
It's noteworthy that approximately 40% of companies opt for more than one SAFE round. Startups frequently return for additional funding to bridge the gap to a seed round, typically within a 12-month timeframe. This multi-round approach underscores the strategic use of SAFEs as a stepping stone in a startup's funding journey, enabling sustained growth and development before reaching later funding stages.
Sector-Specific Challenges
Certain sectors such as Apparel, Edtech, and Direct-to-Consumer (DTC) Retail have encountered challenges, experiencing a downturn from their previous year's figures. These industries, which may be more sensitive to consumer trends and economic cycles, reflect the variable nature of startup success and investor appetite.
Resilience in Venture Funding
Despite the ebb and flow of market conditions, investment through SAFEs in pre-seed companies has remained consistent with previous years. This resilience underscores the robustness of early-stage venture funding and the unwavering pursuit of innovation by entrepreneurs and investors alike.
As we move toward the conclusion of this analysis, it's clear that SAFE fundraising presents a nuanced tapestry of trends across industries. From the vigor of new technologies to the steadfastness of essential sectors, the insights from each industry provide a roadmap for future investments and strategies.
Conclusion
As we wrap up our look at how new companies got money using SAFEs in 2023, there are a few important things to remember:
SAFEs are a popular way for new companies to get started because they let investors give money now and get a part of the company later.
Last year, lots of companies did this, especially in places like California and New York, and they usually asked for more money than companies in other places.
Different kinds of companies, like those working on new internet stuff or clean energy, were really popular and got bigger checks from investors.
It was also common for companies to ask for a certain amount of money, around $10 million, no matter what kind of business they were.
Some types of companies had a tough time, like those making clothes or doing online retail.
Even with all the changes in the world, the amount of money new companies got through SAFEs stayed pretty much the same as the year before.
This tells us that even when times are tough, people are still willing to invest in new ideas and help new companies grow. It's all about finding the right people who believe in what the company wants to do.
So, whether you're someone who wants to start a company or someone looking to invest in new ideas, SAFEs could be a good way to go. The key is to understand what investors are looking for and how much they are willing to give. With this knowledge, new companies can plan better, and investors can make smarter choices.
Let's keep an eye on how SAFEs help new companies in the future. It's an exciting part of the business world that can lead to some really cool new products and services!
