Startups: The Ecosystem and How They're Funded · Part 4 of 8
Financing Instruments and Valuation
SAFEs, convertible notes, and priced rounds, and the pre-money and post-money arithmetic behind a priced round.
When an investor hands a startup money, that exchange has to be documented in one of a few standard legal forms. Each one answers the same underlying question (how much of the company does this money buy) on a different timeline and with different mechanics. Three instruments cover the large majority of early-stage deals.
SAFE (Simple Agreement for Future Equity)
A SAFE is an agreement to convert an investor's cash into equity at a future date, rather than issuing shares with a fixed price right now. It carries no interest and no maturity date, so it isn't a loan. It is fast to sign and cheap to draft, and it is the most common instrument at pre-seed: Carta's Q1 2025 data showed SAFEs in about 90 percent of pre-seed rounds, with convertible notes in most of the rest (Carta covers only companies on its own cap-table platform). It sits dormant until a triggering event, usually the company's next priced equity round, and then converts into preferred shares. Two terms set the price it converts at:
- Valuation cap: the maximum company valuation at which the SAFE converts into shares, protecting the early investor from a smaller stake if the company's valuation jumps sharply before the next priced round.
- Discount: a percentage reduction on the price per share the SAFE converts at, compared to what the next round's investors pay, rewarding the early investor for taking risk sooner.
SAFEs are typically used at the pre-seed and seed stage, when a company's valuation is hard to pin down and both sides would rather defer that argument to a later round with more evidence to go on.
Convertible note
A convertible note is a SAFE's older sibling: debt, carrying an interest rate and a maturity date, that also converts into equity under similar cap-and-discount terms. Because it's legally debt, it typically ranks ahead of equity if the company fails and its assets get distributed. The maturity date also forces a resolution by a set point (conversion, repayment, or renegotiation) where a SAFE can sit indefinitely. Notes were the usual instrument before Y Combinator introduced the SAFE in 2013, and they are still used where a SAFE isn't the local standard or where an investor wants debt-like protections.
Priced equity round
A priced round sets a valuation for the company today and sells shares of preferred stock at an agreed price per share, rather than deferring the valuation question. Priced rounds carry more legal weight and cost more in legal fees to close than a SAFE, because they involve a full set of financing documents: a stock purchase agreement, an investor rights agreement, and a charter amendment defining what the new preferred shares are entitled to. They are the norm from Series A onward, once a company's valuation is evidenced well enough for both sides to agree on a number, and some seed rounds are priced too.
Pre-money and post-money valuation
A priced equity round rests on two numbers that are easy to confuse. They describe two different moments in the same transaction.
- Pre-money valuation: what the company is worth immediately before the new investment is added.
- Post-money valuation: what the company is worth immediately after, which is the pre-money valuation plus the money just invested.
Suppose a company and an investor agree the company is worth $8,000,000 before any new money comes in, and the investor puts in $2,000,000. The post-money valuation is $10,000,000. The investor's ownership percentage is their investment divided by the post-money valuation, because ownership is measured against what the company is worth including the money that just bought that ownership.
That 20% comes from newly issued shares, which is why a priced round dilutes everyone who held shares before it closed. The next lesson follows that dilution across an entire cap table.