How to Model SAFEs and Convertible Notes on a Pro-Forma Cap Table

Understanding How to Model Dilution from SAFEs and Convertible Notes

For many early-stage SaaS, Biotech, and Deeptech startups, raising initial capital via a SAFE (Simple Agreement for Future Equity) or a convertible note is a standard first step. These instruments are fast and avoid the immediate need to set a firm company valuation. The real complexity isn't signing the note; it’s understanding what happens during your first priced round of funding. Failing to model how these instruments convert can lead to significant, unexpected founder dilution and a weaker negotiating position.

Learning how to model dilution from SAFEs and convertible notes isn't just a finance exercise; it's a core competency for founders managing their equity proactively. Miscalculations can erode your ownership more than you anticipated and create friction with new investors who find the share price is different from what they expected. This guide provides a practical framework for building this understanding from the ground up, helping you protect your equity and negotiate with confidence.

The Conversion Waterfall: Why Sequence is Everything

Before you can model your cap table, you must understand the sequence of events, often called the “conversion waterfall.” This is the precise order of operations for calculating your company’s new ownership structure, or pro-forma cap table, following a new investment. The trigger for this entire process is a priced round, like a Series A, where new investors purchase a specific number of shares at a negotiated price per share.

The conversion process becomes a complex problem at this stage because the pre-money valuation you agree upon with your new Series A investor isn't the full story. The shares issued to converting SAFE and note holders are created before the new investor’s money comes in. This action increases the total number of pre-investment shares, effectively lowering the price per share for those new investors and changing the capitalization base upon which their ownership is calculated.

This is often called the 'Pre-Money Illusion'. Founders may believe a $10 million pre-money valuation on an existing 8 million shares means a $1.25 share price, but that is rarely the case. Getting the sequence wrong in your spreadsheet leads to incorrect share counts for everyone. The key is to calculate the conversion of old instruments first to determine the fully-diluted pre-round capitalization, and only then calculate the shares for the new money.

The Three Levers of Dilution: Cap, Discount, and Interest

Every convertible instrument's impact on your cap table is controlled by three main levers. Understanding how they interact is crucial for any cap table scenario analysis, as they determine the final price your early investors pay for their equity.

1. The Valuation Cap

A valuation cap sets a maximum valuation at which an investor’s money converts into equity. This term protects early investors from being diluted by a high valuation in a future funding round. The investor gets equity as if the company’s valuation were the lower of the cap or the new round's pre-money valuation. For example, consider a SaaS startup that raised $200,000 on a SAFE with a $4 million valuation cap. If they later raise a Series A at a $10 million pre-money valuation, the SAFE holder doesn't convert at the $10 million valuation. The investor gets the benefit of the $4 million cap, receiving a significantly lower price per share and thus more shares for their investment. For an accessible primer on this, see Carta's explanation of SAFEs.

2. The Discount Rate

This term provides a percentage discount on the share price paid by the new investors in the priced round. It rewards early investors for taking a risk before the company had a firm valuation. If the Series A investors pay $2.00 per share and a convertible note has a 20% discount, the note holder’s investment converts at a price of $1.60 per share ($2.00 * (1 - 0.20)). The discount is most impactful when a company raises its priced round at a valuation lower than or close to the valuation cap.

3. The 'Lesser Of' Rule and Interest

The cap and discount almost always work together under the 'lesser of' rule. The investor's money converts at the share price that is most favorable to them. To determine this, you calculate the effective share price using the valuation cap and separately calculate the price using the discount. The investor receives shares based on the lower of the two prices. For convertible notes, which are common in certain US financings and prevalent in the UK, accrued interest often gets added to the principal investment amount. This combined total then converts into equity, further increasing the number of shares the investor receives. In contrast, modern YC SAFEs do not typically accrue interest.

Core Calculation: A SAFE Conversion Example in a Priced Round

Understanding the theory is one thing; applying it is another. Let’s walk through the math step-by-step to show how to model dilution from SAFEs and convertible notes. We will use a common scenario for a US-based tech company raising a Series A. This exercise is essential for building an accurate founder ownership after SAFE conversion model.

Here are the parameters for our scenario:

• Existing Capitalization: 8,000,000 shares (held by Founders & an Employee Stock Option Pool, or ESOP).
• Convertible Instrument: A single SAFE of $500,000 with an $8M post-money valuation cap and a 20% discount.
• New Funding Round: A Series A round of $2,000,000 at a $10,000,000 pre-money valuation.

A key piece of information is that this is a 'Post-Money' SAFE, which has been the YC (Y Combinator) standard since 2018. This type of SAFE is designed to represent a percentage of the company before the new priced round money is added. You can learn more about its origins from YC on the post-money SAFE.

Step 1: Calculate the SAFE Holder's Pre-Money Ownership Percentage

The post-money SAFE's cap determines its ownership stake in the company right before the Series A investment closes. The formula is straightforward.

Ownership = SAFE Investment / Valuation Cap = $500,000 / $8,000,000 = 6.25%

This 6.25% represents the SAFE holder's share of the company capitalization *after* their own instrument converts but *before* the new Series A investment is factored in.

Step 2: Calculate the Shares Issued to the SAFE Holder

Now, we solve for the number of new shares ('S') the SAFE holder will receive. Their 6.25% ownership applies to a total that includes the existing shares plus their own new shares.

S / (8,000,000 existing shares + S) = 0.0625

Solving for S:

S = 0.0625 * (8,000,000 + S)
S = 500,000 + 0.0625S
0.9375S = 500,000
S = 533,333 shares

The effective share price for the SAFE holder is their investment divided by the shares they receive: $500,000 / 533,333 shares = $0.9375 per share.

Step 3: Calculate the Price Per Share for New Series A Investors

The Series A investors are buying shares based on the $10M pre-money valuation, but that valuation is now applied to a company with more shares outstanding due to the SAFE conversion. This is where we see the 'Pre-Money Illusion' in action.

New Share Count (Pre-Money) = 8,000,000 (Existing) + 533,333 (SAFE) = 8,533,333 shares
Series A Price Per Share = $10,000,000 Valuation / 8,533,333 Shares = $1.171875

The dilution from the SAFE has lowered the effective share price for the new investors from a simplistic $1.25 ($10M / 8M shares) to $1.17.

Step 4: Check the 'Lesser Of' Rule

We must confirm that the valuation cap provided a better price for the SAFE holder than the discount. The price from the discount would have been based on the Series A price.

Discount Price = $1.171875 * (1 - 0.20) = $0.9375

In this specific case, the price derived from the valuation cap and the price from the discount are identical. The SAFE holder converts at $0.9375 per share.

Step 5: Calculate the Final Pro-Forma Cap Table

Finally, we can assemble the complete picture of ownership. First, we calculate the number of shares the new investors receive for their $2 million.

Series A Shares = $2,000,000 Investment / $1.171875 per share = 1,706,667 shares

Now we can see the full post-money capitalization:

• Founders & ESOP: 8,000,000 shares (78.13%)
• SAFE Holder: 533,333 shares (5.21%)
• Series A Investors: 1,706,667 shares (16.67%)
• Total Post-Money Shares: 10,240,000 shares (100.00%)

This step-by-step process demonstrates how to model dilution from SAFEs and convertible notes accurately, avoiding common pitfalls and ensuring all parties have a clear understanding of the outcome.

Advanced Scenario: Modeling Multiple Notes and Pre/Post-Money SAFEs

The complexity of a SAFE conversion example increases significantly when a company has raised capital with multiple instruments. Imagine an e-commerce startup with two SAFEs and one convertible note, all converting in the same priced round. The cascade effect of these conversions can quickly make spreadsheets brittle and prone to error, which is why cap table scenario analysis is so important.

Pre-Money vs. Post-Money SAFEs

A critical distinction arises between the older 'pre-money' SAFE and the current 'post-money' YC standard. A pre-money SAFE's conversion calculation is based on the company capitalization before other SAFEs convert, meaning its dilution is felt primarily by founders and existing shareholders. A post-money SAFE's conversion is based on the capitalization including other converting instruments, meaning its dilution is shared more broadly by founders and other convertible investors.

Consider this simplified comparison:

• Pre-Money SAFE: A $250k SAFE with a $5M cap converts into a company with 1 million shares. Its price is based on the cap ($5M / 1M shares = $5/share), creating 50,000 new shares. The calculation is simple and self-contained.
• Post-Money SAFE: The same SAFE claims a percentage of the company (e.g., $250k / $5M cap = 5%). This 5% must be calculated against a share base that includes itself and all other converting instruments, often resulting in more shares (e.g., 52,632 in a typical scenario) than the pre-money version. The practical consequence tends to be slightly more dilution for founders.

A scenario we repeatedly see is founders struggling to consolidate these different instruments in a single spreadsheet. When you have a mix of pre-money notes, post-money SAFEs, and different terms within each, the circular logic required to get the calculations right is a significant challenge. This is the point where relying on a simple equity dilution calculator is insufficient. Migrating to dedicated cap table software like Carta or Pulley becomes a necessity to ensure accuracy for investors, accounting (under US GAAP or FRS 102), and legal compliance.

Strategic Takeaways for Founders

Modeling your cap table isn't just an administrative task; it's a strategic tool for managing your company’s future. For founders at the pre-seed to Series B stage, often operating without a dedicated CFO, focusing on a few core principles can prevent costly surprises and strengthen your negotiating position.

1. Negotiate Terms, Not Just the Headline Number

Recognize that the terms of a SAFE or note often matter more than the headline valuation of a future round. An aggressive valuation cap or a steep discount on early funding can cause more dilution than a slightly lower pre-money valuation in your Series A. The key is to run a basic cap table scenario analysis, even in a simple spreadsheet, before you sign any convertible instrument. Understand the potential impact of each lever on your ownership. Model this before you sign.

2. Understand Geographic Nuances

Be aware of regional differences in financing instruments. While this article focused on the YC SAFE common in the USA, instruments in the UK like the Advanced Subscription Agreement (ASA) often have different mechanics. An ASA is structured to comply with the UK's Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS), which provide significant tax relief to investors. This often means they have longstop dates and other terms not found in a typical SAFE. For companies operating across both jurisdictions, getting localized legal and financial advice is essential. For more on this, see our guide to UK share classes and cap table structure.

3. Know When to Graduate from Spreadsheets

For a single financing instrument, Google Sheets or Excel is perfectly adequate for modeling. However, once you have multiple converting notes or SAFEs, especially with a mix of pre-money and post-money terms, the risk of a circular reference error or a simple mistake becomes too high. This is the trigger point to transition to a dedicated cap table platform. These tools automate the conversion waterfall and provide a single source of truth for you, your investors, and your accountants, whether they use QuickBooks in the US or Xero in the UK.

If you need to build pro-forma scenarios for investor discussions, start with the mechanics described here. As you progress, move to a tool that supports what-if modeling and maintains an audit trail. To learn more about subsequent rounds, see our guide on Dilution Modeling Through Multiple Rounds, and consider how your option pool interacts with fundraising with our Option Pool Management guide. Continue exploring cap table fundamentals at our topic hub: Cap Table Basics.

Frequently Asked Questions

Q: What is the biggest mistake founders make when modeling SAFE and note conversions?
A: The most common error is misinterpreting the 'pre-money' valuation. Founders often apply it only to the existing shares, forgetting that converting instruments increase the share count before the new money comes in. This is the 'Pre-Money Illusion', and it leads to an incorrect, higher share price and an underestimation of dilution.

Q: How does the employee option pool (ESOP) affect these calculations?
A: An ESOP is part of the fully diluted capitalization. In most priced rounds, investors will require the option pool to be refreshed or increased before their investment. This increase happens at the pre-money valuation, diluting existing shareholders (including founders) but not the new investors. It's another critical step in the conversion waterfall.

Q: Can I negotiate the terms of a standard YC SAFE?
A: While the core mechanics of the YC SAFE are standardized for simplicity, the key inputs—the valuation cap and the discount—are negotiable. Founders should absolutely negotiate these terms based on the strength of their company, market conditions, and advice from their legal counsel to achieve a fair outcome.

Q: Does a convertible note show up as debt on my balance sheet?
A: Yes, a convertible note is technically a debt instrument until it converts to equity. It will appear as a liability on your company's balance sheet, which can be relevant for accounting and solvency assessments. SAFEs, on the other hand, are generally not considered debt, offering a cleaner balance sheet for early-stage companies.