Tech start-ups load up on SAFE notes but face a big problem in 2023

“There will be a lot of SAFEs converting next year; normally they would be based on equity round but now they will convert only based on the maturity date and it will do so at a set price [if the company does not raise again].”

Trouble around the corner

Mr. Heine said the valuations set in this year’s clutch of SAFEs are typically flat, but there are provisions for it to be converted to a price below the stated price or at a discount to a future equity round.

Maturity dates put pressure on founders to complete the next raise by that time if they believe they can raise at a higher price. If a founder is starting the process, needs capital, but cannot find an investor willing to invest at a higher price, this opens up the real problem of 2023.

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“The biggest fear hanging over us is that the next round is the bottom round. It’s a real disaster, so let’s hope it doesn’t happen to the founders,” Mr Heine said.

“There are a lot of ifs and buts … but conversion [at a maturity date] It wouldn’t be a completely negative outcome for the founders, because they can predict what the dilution will be now and consider that they have already given it.

“But if there’s a low round, many investors will also have anti-dilution mechanisms, which means the round will have more negative impact on the founder than previous investors, and it will have a really big impact.”

Most SAFEs raised for Series A-stage companies range from $1 million to $3 million, and most are designed to extend the company’s runway by 12 to 18 months.

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Big companies will be hit harder

With many bridge rounds raised this year, startups will need to catch up to their previous valuations to avoid lower rounds in 2023.

This will have a greater impact on larger companies, such as Canva, whose investors may already be priced on their books.

Music licensing platform Songtradr is in the market for new funding, cutting its valuation 17 percent to $425 million from its March launch of a raise that was later canceled.

When Buildxact returned to investors in early September to raise $5 million in additional capital, it was valued at $121.3 million, up from $125 million in January.

According to Mr. Heine, for the most part, companies have delayed setting new valuations this year.

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Gavin Appel, founder of Ignition Lane, said founders make decisions that ensure the survival of their companies, but investors have an obligation to act in the startups’ best interests.

“Their main task is not to run out of cash,” he said.

“But this is a long-term game. It’s important for founders and investors alike to understand that founders need to be incentivized to maximize shareholder returns in the long run – do they have enough skin in the game to hit the stars and bring in big returns?

“Founders may be more diluted than they were last year or the year before, and that may not be a good thing for investors.”

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