Convertible instruments

Why the post-money SAFE moved the dilution

Under a pre-money SAFE, multiple SAFEs converting in the same round dilute each other, so no holder knows their final percentage until the round closes. A post-money SAFE fixes each holder's percentage of the post-money capitalisation, so subsequent SAFEs no longer dilute earlier ones - founders absorb all of it.

Field	Value
Formula	Post-money SAFE ownership = investment / valuation cap
Worked	500,000 on an 8,000,000 post-money cap = 6.25 percent, fixed
Stacking effect	Four such SAFEs = 25.00 percent, all from founders and existing holders

• The instrument is clearer and easier to model. It is also strictly more dilutive to founders than the pre-money version at the same headline cap.
• The common failure is raising several post-money SAFEs at different caps over time without maintaining a running total of committed post-money ownership.
• Model the aggregate before signing the second one, not before the priced round.

Also described at: Wikipedia · Wikidata · Y Combinator SAFE User Guide

Convertible note maturity

The date at which the note becomes repayable if no qualified financing has occurred. Because a company at that stage usually cannot repay, maturity functions as a renegotiation trigger rather than a repayment date.

• Common outcomes at maturity: extension, conversion at a negotiated valuation, or conversion at the cap by prior agreement.
• The holder's leverage at maturity is the ability to declare default. This is rarely exercised but shapes the negotiation.
• SAFEs were designed specifically to remove this dynamic by having no maturity.

Also described at: Wikipedia · Wikidata

Qualified financing threshold

The minimum size of a priced equity round that triggers automatic conversion of the instrument. Rounds below the threshold do not force conversion.

• Set too high, a genuine priced round fails to trigger conversion and the instruments hang over the cap table.
• Set too low, a small insider round can force conversion at terms the holder would not have chosen.
• Check that the threshold is consistent across every outstanding instrument. Inconsistent thresholds across a stack of notes create a partial conversion that is difficult to model and worse to negotiate.

Pre-money and post-money SAFE conversion arithmetic

Both instruments use a valuation cap, and on identical headline terms they produce different share counts, different round prices, and different founder ownership. The difference is which capitalisation the cap is divided by.

Field	Value
Formula	Pre-money SAFE: CP = cap / FD, where FD excludes the shares issuable on conversion of the SAFEs. Post-money SAFE: ownership = I / cap of the capitalisation after all SAFEs convert and before new money, so CP = cap / S where S = FD / (1 - sum of I_k/cap_k)
Setup	I = 1,000,000, cap = 8,000,000, FD = 8,000,000 shares. Priced round R = 3,000,000 at PRE = 12,000,000
Worked, pre-money	CP = 8,000,000/8,000,000 = 1.0000 -> 1,000,000 shares. Round price = 12,000,000/9,000,000 = 1.3333 -> 2,250,000 new shares. Total 11,250,000. SAFE holds 8.889 percent
Worked, post-money	S = 8,000,000/(1 - 0.125) = 9,142,857; CP = 8,000,000/9,142,857 = 0.8750 -> 1,142,857 shares. Round price = 12,000,000/9,142,857 = 1.3125 -> 2,285,714 new shares. Total 11,428,571. SAFE holds 10.000 percent
Who pays the difference	The new investor holds 20.000 percent either way. Founders and existing holders move from 71.111 to 70.000 percent, so the entire 1.111 point difference comes out of them

• The post-money version is easier to model precisely because it fixes the answer in advance, and that is exactly why it costs founders more: certainty for the holder has to be funded by someone, and the only party left is the existing cap table.
• The two instruments are not interchangeable at the same cap. Converting a pre-money term sheet to a post-money document without moving the cap is a real price change, not a documentation cleanup. The cap that leaves the holder in the same position is the pre-money cap plus the amount raised on the instruments: a 9,000,000 post-money cap issues exactly the same 1,000,000 shares as an 8,000,000 pre-money cap on 1,000,000 invested.
• Y Combinator publishes the post-money SAFE in valuation-cap, discount, and most-favoured-nation variants. Check which template is actually attached before modelling anything.
• Both instruments define their own capitalisation term. Read that definition rather than assuming it matches the fully diluted count the term sheet uses elsewhere.

Source: Y Combinator SAFE templates (pre-money 2013 series; post-money 2018 series)

Also described at: Wikipedia · Wikidata · Y Combinator SAFE User Guide

Valuation cap versus discount - which one binds

An instrument carrying both a cap and a discount converts at whichever produces the lower price. Which one that is depends only on the round's valuation, and the switchover point is a single number known at signing.

Field	Value
Formula	The cap binds when cap / FD < (PRE / FD)*(1 - discount), which reduces to PRE > cap / (1 - discount). Below that valuation the discount binds
Worked	cap = 8,000,000, discount = 0.20: the switchover is PRE = 8,000,000/0.80 = 10,000,000
Above it	At PRE = 12,000,000 on FD = 8,000,000: cap price 1.0000 against discount price 1.5000*0.80 = 1.2000. The cap binds
Below it	At PRE = 9,000,000 on the same FD: cap price 1.0000 against discount price 1.1250*0.80 = 0.9000. The discount binds

• The switchover is independent of the share count, because FD cancels out. It depends only on the cap and the discount, so it can be computed the day the instrument is signed.
• A discount is protection against a round priced near the cap; a cap is protection against a round priced far above it. An instrument with only a discount has no upside protection at all, and an instrument with only a cap has no protection in a flat or down round.
• Negotiating the discount when the expected round is well above cap / (1 - discount) is negotiating a term that will never apply. Compute the switchover first and spend the negotiation on whichever term will actually bind.

Also described at: Y Combinator: the SAFE

Most favoured nation

An MFN provision lets the holder elect the terms of any later instrument the company issues before conversion. It converts a signed price into a ceiling on price, and it applies retroactively to every MFN instrument outstanding.

Field	Value
Formula	Effective cap for an MFN holder = min(own cap, caps of all later qualifying instruments issued before conversion). Shares = I / (effective cap / FD)
Worked	A holder signs 1,000,000 at a cap of 8,000,000 on FD = 8,000,000, so CP = 1.0000 and 1,000,000 shares. The company later issues at a 6,000,000 cap
After election	Effective cap 6,000,000: CP = 6,000,000/8,000,000 = 0.7500, so 1,000,000/0.75 = 1,333,333 shares - a 33.3 percent increase for the same money

• A later cheap instrument is more expensive than its own headline suggests, because it reprices every MFN instrument behind it. Before signing a lower cap, total the MFN paper outstanding and reprice it at the new cap.
• MFN is usually one sentence and is often the only term in a small early instrument, since a holder with no cap and no discount has nothing else to rely on.
• The election is typically exercisable at a defined point rather than continuously, and it usually excludes the priced round itself. Whether a later instrument is a qualifying one is a drafting question with a large arithmetic consequence.

Source: Y Combinator SAFE (MFN variant)

Also described at: Y Combinator: the SAFE (MFN form)

Pro-rata rights and what maintaining ownership costs

A pro-rata right entitles the holder to buy enough of a future round to keep its percentage flat. The arithmetic is simpler than it looks: buying its own percentage of the new money is exactly sufficient, whatever the round price.

Field	Value
Formula	To hold ownership constant at q through a round raising R, the holder must invest q*R. Post-round ownership = (q*s_pre + q*s_new)/(s_pre + s_new) = q
Worked	A SAFE holder at 10.000 percent after conversion. The next round raises R = 10,000,000: maintaining 10.000 percent costs 0.10*10,000,000 = 1,000,000
If the holder passes	Ownership falls to 10.000 percent * PRE/POST. At PRE = 40,000,000, POST = 50,000,000: 10.000 * 0.80 = 8.000 percent

• The right is an option struck at the round price, and like any option it is worth most when the round is priced well and worth nothing when it is priced badly. Its value is not the ownership it preserves but the ability to decline.
• The cost to the company is allocation, not cash: every dollar reserved for pro-rata is a dollar the new lead cannot take, which is why leads negotiate pro-rata waivers as a condition of a competitive round.
• The post-money SAFE moved pro-rata out of the instrument and into a separate side letter. If no side letter was signed, the right does not exist regardless of what was discussed.

Source: Y Combinator SAFE (post-money) and the accompanying pro-rata side letter

Also described at: Wikipedia · Wikidata · Y Combinator pro rata side letter

How converting instruments interact with the priced round

Converting instruments are normally placed inside the pre-money share count used to price the round. That single convention decides who absorbs the conversion: the new investor's percentage is fixed by its cheque and the post-money valuation, so every additional converting share dilutes only the existing holders.

Field	Value
Formula	If converting instruments sit inside the pre-money count, new investor ownership = R/POST regardless of how much converts. Existing holder ownership = s_existing / (FD + converting shares + R/price)
Worked	R = 3,000,000 at PRE = 12,000,000, so R/POST = 3,000,000/15,000,000 = 20.000 percent. The new investor holds 20.000 percent whether the SAFE converts into 1,000,000 shares or 1,142,857
Where it lands	The extra 142,857 shares move founders and existing holders from 71.111 to 70.000 percent - the whole difference
The general rule	Anything inside the pre-money count is paid for by the pre-money holders

• This is the same mechanism as the option pool shuffle, applied to convertible instruments instead of options. Once the principle is seen in one place it explains most cap table surprises: the pre-money share count is where the cost of everything gets allocated.
• It also means the new investor has no economic reason to police the conversion arithmetic, since its own percentage is protected either way. The founder is the only party with an incentive to check it.
• Ask for the closing cap table with converting instruments shown as a separate line, not folded into the pre-money total. The fold is where errors hide.

SAFE stacking and the over-dilution failure mode

Post-money SAFE ownership is additive and fixed, so a series of instruments signed at different caps commits a total percentage that can be computed exactly at any time. The failure mode is not signing a bad instrument; it is signing four reasonable ones without ever adding them up.

Field	Value
Formula	Committed ownership = sum of I_k/cap_k. Founders and existing holders retain 1 - that sum before new money, and (1 - sum)*(1 - q) after a round selling q
Setup	500,000 at 6,000,000; 750,000 at 8,000,000; 1,000,000 at 12,000,000; 250,000 at 5,000,000. Total raised 2,500,000
Worked	8.333 + 9.375 + 8.333 + 5.000 = 31.042 percent committed before any priced round
Implied blended cap	2,500,000/0.31042 = 8,053,691 post-money - well below the 12,000,000 headline of the largest instrument
After a round selling 20 percent	(1 - 0.31042)*0.80 = 55.167 percent to founders and existing holders

• Caps do not average. Ownership is I/cap, which is convex in the cap, so the low-cap instruments dominate the blended result. Raising a small amount at a low cap is disproportionately expensive relative to its size.
• The single number worth maintaining is the running sum of I/cap. It requires no model, no assumptions about the next round, and it is exact. Recompute it before signing each instrument, not before the priced round.
• This clean additivity holds only for post-money instruments. Pre-money SAFEs dilute one another, so summing I/cap across them overstates the committed total - which is a different problem, not a smaller one, because the total is then unknowable until the round closes.

Also described at: Wikipedia · Wikidata · Y Combinator SAFE User Guide

Mixed pre-money and post-money instruments create a circular calculation

A post-money instrument takes a fixed percentage of a capitalisation that includes all converting shares. A pre-money instrument takes a fixed share count based on a capitalisation that excludes them. Put both in the same round and each depends on the other.

Field	Value
Formula	Solve S = FD + sum of shares_j(S) by substitution. With one pre-money instrument issuing a fixed s_pre and one post-money instrument taking fraction w: S = (FD + s_pre)/(1 - w)
Setup	FD = 8,000,000. Pre-money SAFE of 500,000 at a 10,000,000 cap. Post-money SAFE of 1,000,000 at an 8,000,000 cap (w = 0.125)
Worked, pre-money leg	CP = 10,000,000/8,000,000 = 1.2500 -> 500,000/1.25 = 400,000 shares, fixed
Worked, post-money leg	S = (8,000,000 + 400,000)/(1 - 0.125) = 9,600,000 -> 0.125*9,600,000 = 1,200,000 shares
Result before new money	Existing 8,000,000/9,600,000 = 83.333 percent; pre-money SAFE 4.167 percent; post-money SAFE 12.500 percent

• The post-money holder's share count rose from 1,142,857 alone to 1,200,000 here, purely because the pre-money instrument enlarged the base it takes a fixed percentage of. It is diluted by nothing and expanded by everything.
• The pre-money holder is diluted by the post-money holder and receives nothing in return. Where both instruments exist, the older paper is systematically worse off, which is the opposite of the usual assumption that earlier money is better priced.
• Add a discount, an MFN election, or a note accruing interest to the same stack and there is no closed form left at all. Solve it numerically and reconcile the share counts against the closing cap table line by line.

Also described at: Y Combinator SAFE User Guide

Note interest expressed as a discount

Accrued interest buys extra shares at the same conversion price. That is arithmetically identical to a discount on the price, which makes the two terms directly comparable once the holding period is fixed.

Field	Value
Formula	Equivalent discount = 1 - 1/(1 + r*t) for simple interest. With both interest and a stated discount, total shares = (I*(1 + r*t))/(CP*(1 - discount)), a multiplier of (1 + r*t)/(1 - discount) on the no-terms case
Worked	r = 0.06, t = 1.5: 1 - 1/1.09 = 8.26 percent equivalent discount
Worked, longer and dearer	r = 0.08, t = 2.0: 1 - 1/1.16 = 13.79 percent
Both terms together	r = 0.06, t = 1.5, discount 0.20: multiplier = 1.09/0.80 = 1.3625, so 36.25 percent more shares than principal at the round price

• Interest and a discount stack multiplicatively, not additively. A note with 6 percent interest held eighteen months and a 20 percent discount is a 26.61 percent effective discount on price, computed as 1 - 1/1.3625, not the 28.26 percent that adding the two terms suggests.
• Interest keeps accruing while the round is being negotiated, so every week of delay is a small transfer from the cap table to the noteholder. On a large note stack that is a real reason to close rather than optimise the last term.
• Some notes convert principal only and pay or waive interest in cash. That is a materially cheaper instrument at the same headline rate, and it is a one-line change to ask for.

When the priced round comes in below the cap

A valuation cap sets the conversion price by dividing the cap by a capitalisation. It is not a most-favoured price and it is not automatically the lower of the cap price and the round price. If the round prices below the cap, the standard documents still convert the instrument at the cap price.

Field	Value
Formula	Cap price = cap / S. Round price = PRE / S. The instrument is worse off than new money whenever PRE < cap, by a factor of cap/PRE
Setup	Post-money SAFE of 1,000,000 at an 8,000,000 cap on FD = 8,000,000, so S = 9,142,857 and the cap price is 0.8750
Worked	The round closes at PRE = 5,000,000: round price = 5,000,000/9,142,857 = 0.5469. The SAFE converts at 0.8750, which is 8,000,000/5,000,000 = 1.60x the price the new investor pays
The general result	The holder overpays by cap/PRE whenever the round prices below the cap

• A cap is a ceiling on price, not a floor on ownership. The instrument protects against the company becoming more valuable and offers nothing at all against it becoming less valuable - which is the outcome the holder was actually exposed to.
• This is the strongest practical argument for an MFN term or an explicit price floor. Both are short to draft and neither costs anything in the outcome where the round prices above the cap.
• Check the specific document rather than assuming. Conversion price definitions vary between templates and between amended instruments, and the difference between 'the SAFE price' and 'the lesser of the SAFE price and the price paid in the equity financing' is the entire question.

Solving a mixed pre-money and post-money stack in one step

Pre-money instruments fix a share count and post-money instruments fix a fraction of a total that includes those shares. With several of each the two rules are simultaneous, but the system is linear and collapses to a single division.

Field	Value
Formula	S = (FD + sum of fixed pre-money share counts) / (1 - sum of post-money fractions w_k), where w_k = I_k/cap_k. Each post-money instrument then receives w_k*S shares
Setup	FD = 8,000,000. Pre-money SAFE 500,000 at a 10,000,000 cap; post-money SAFEs of 1,000,000 at 8,000,000 and 750,000 at 12,000,000
Pre-money leg	CP = 10,000,000/8,000,000 = 1.2500, so 400,000 shares, fixed
Post-money fractions	w = 1,000,000/8,000,000 + 750,000/12,000,000 = 12.500 + 6.250 = 18.750 percent
Solve	S = (8,000,000 + 400,000)/(1 - 0.187500) = 10,338,462
Shares	Post-money instruments take 1,292,308 and 646,154. Check: 8,000,000 + 400,000 + 1,292,308 + 646,154 = 10,338,462
After a round of 3,000,000 at PRE 12,000,000	Round price 1.1607, new shares 2,584,615, total 12,923,077. New investor 20.000 percent, existing holders 61.905 percent

• The order of signature is irrelevant to the arithmetic and decisive to the outcome. Every post-money instrument takes its fraction of a base that the pre-money instruments have already enlarged, so the pre-money holders subsidise the post-money holders and receive nothing for it.
• Add a discount, an MFN election or accruing interest and the system stops being linear, because the conversion price then depends on the round price which depends on S. Solve those numerically and reconcile share counts against the closing cap table line by line.
• The single number worth tracking while the instruments are being signed is the running sum of w. It is exact, it needs no forecast of the next round, and it is the fraction of the company already committed.
• Existing holders here end at 61.905 percent having sold 2,250,000 of instruments and 3,000,000 of equity against an 8,000,000-share starting position. Compute that figure before the second instrument, not before the round.

Source: Y Combinator SAFE templates (pre-money 2013 series; post-money 2018 series)

A discount-only instrument inside a capped stack

A discount with no cap prices off the round, so its share count depends on the round price, which depends on the total pre-money count, which includes its own shares. It is the one common instrument whose conversion is genuinely circular even on its own.

Field	Value
Formula	Shares = I / (discount factor * PRE / S) = I*S/((1 - discount)*PRE), which is a fixed multiple k of S. The stack then solves as S = (FD + fixed pre-money shares)/(1 - sum of w_k - k)
Setup	The three-instrument stack above, plus 250,000 at a 20 percent discount and no cap
The multiple k	250,000/(0.80000 * 12,000,000) = 0.02604167 shares per share of S
Solve	S = (8,000,000 + 400,000)/(1 - 0.187500 - 0.026042) = 10,680,795
Discount instrument's shares	278,146 at a conversion price of 0.8988 against a round price of 1.1235
Effect on the round price	The round price falls from 1.1607 to 1.1235 because the pre-money count is larger
Effect on existing holders	From 61.905 to 59.921 percent

• A discount is protection against a round priced near where the instrument was signed. It gives nothing at all against a round priced far above, which is precisely the case in which a cap would have been worth something. An instrument with only a discount is unprotected on the upside.
• Because the discount is applied to the round price and the round price is depressed by every converting share, a discount instrument in a large stack converts at a lower absolute price than it would alone. It is the only instrument in the stack that benefits from the others being there.
• The circularity is a real modelling trap: solving for the round price with the discount shares omitted and then adding them produces a price that is too high and a share count that is too low. The closed form above removes the iteration.
• Where the same instrument carries both a cap and a discount, only one binds, and which one is known at signing from PRE against cap/(1 - discount). Compute that before negotiating either term.

Interest conventions change the share count without changing the rate

A note's stated rate is not sufficient to compute what converts. The day-count basis, the compounding frequency and whether interest converts or is paid in cash each move the amount, and on an eighteen-month hold the spread between the cheapest and dearest of the common conventions is 3,929 on 90,000 of interest, or 4.365 percent of it.

Field	Value
Formula	Amount converting = principal * (1 + f), where f is the accrual factor: r*t for simple accrual with t on the stated basis, or (1 + r/n)^(n*t) - 1 for compounding n times a year
Simple, 30/360, 1.500 years	Interest 90,000, amount 1,090,000, equivalent discount 8.257
Simple, actual/360, 548 days	Interest 91,333, amount 1,091,333
Compounded monthly	Interest 93,929, amount 1,093,929
Spread across the conventions	3,929 of extra shares at a conversion price of 1.0000, on the same stated 6 percent
Interest plus a 20 percent discount	Multiplier = 1.09000/0.80000 = 1.3625, so 36.250 percent more shares than principal at the round price

• Actual/360 is the convention that quietly pays the most, because it divides a real number of days by a 360-day year. On a stated 6 percent it delivers an effective 6.083 percent over a 365-day year, computed as 0.06 * 365/360, and nobody negotiating the rate mentions it.
• Interest accrues while the round is being documented, so the conversion amount is a function of the closing date. On a large note stack that makes speed worth more than the last term being argued over.
• Notes that pay or waive interest in cash rather than converting it are materially cheaper instruments at the same headline rate, and asking for that is a one-line change. It converts a dilution cost into a cash cost at a moment when the company has just raised cash.
• Reconcile the conversion amount with the noteholder in writing before the closing cap table is built. A one-day disagreement about the accrual end date is a share count disagreement, and share counts are what get filed.

The trigger set, not the cap, decides when an instrument converts

A convertible instrument specifies the events on which it converts and the rule that applies to each. The valuation cap is only the price used on one of those paths. Two instruments with the same cap and different trigger sets are different securities.

Field	Value
Formula	No single formula. Each path has its own rule: an equity financing converts at the instrument's conversion price, a liquidity event pays the greater of the purchase amount and the as-converted proceeds, a dissolution pays the purchase amount out of remaining assets
Qualified financing threshold	A minimum round size above which conversion is automatic. Below it, conversion is usually optional or does not occur
Maturity	Present in notes and absent from SAFEs. At maturity the note is repayable, which in practice makes it a renegotiation date
Liquidity event	A change of control or public offering before any priced round. The holder elects the better of a cash claim and conversion
Dissolution	A wind-up. The holder ranks behind creditors and ahead of common for the purchase amount
Worked, the liquidity election	A 1,000,000 post-money SAFE at an 8,000,000 cap holds 12.500 percent. At E = 20,000,000 conversion pays 2,500,000; at E = 6,000,000 the 1,000,000 cash claim is better. Indifference is at E equal to the cap

• The indifference point in a liquidity event is exactly the cap, and the algebra is one line: conversion pays (I/cap)*E, which equals I when E equals cap. That gives the holder a clean rule and gives the founder a clean warning about what a small early sale actually costs.
• An inconsistent threshold across a stack of instruments produces a partial conversion, where some instruments convert and others hang over the new cap table with their caps intact. That is difficult to model and worse to negotiate, and it is avoidable by using one threshold.
• Maturity is the only trigger that arrives on a date rather than on an event, which is why it is the only one that reliably forces a conversation. SAFEs removed it deliberately; that is a real transfer of leverage to the company and the main structural difference from a note.
• Read whether conversion on an equity financing is automatic or at the holder's election. An election is worth something to the holder in any round priced below the cap, which is exactly the round in which the company most wants the instrument gone.

The same 1,000,000 as a priced round, a SAFE and a note

On identical headline terms the three instruments produce three ownership figures, three downside claims and three sets of rights. The differences are not a matter of documentation cost; they are economic, and they are computable at signing.

Field	Value
Formula	Priced round: shares = I/(PRE/FD), and ownership is then diluted by later rounds. Pre-money SAFE: shares = I/(cap/FD). Post-money SAFE: ownership = I/cap of the pre-new-money capitalisation. Note: shares = I*(1 + r*t)/(cap/FD)
Priced seed	PRE 8,000,000 on FD 8,000,000: price 1.0000, 1,000,000 shares, 11.111 percent at closing, 8.889 percent after the next round
Pre-money SAFE at an 8,000,000 cap	CP 1.0000, 1,000,000 shares, 8.889 percent after the priced round
Post-money SAFE at an 8,000,000 cap	CP 0.8750, 1,142,857 shares, 10.000 percent after the priced round
Note at an 8,000,000 cap, 6 percent simple, 1.5 years	Converting amount 1,090,000 at CP 1.0000, 1,090,000 shares, 9.593 percent after the priced round
Downside	Only the note is a creditor claim. Both SAFEs rank behind debt and ahead of common. The priced preferred carries a 1,000,000 liquidation preference from day one
Rights	Only the priced round delivers protective provisions, a board seat if negotiated, information rights and anti-dilution at the time the money goes in

• The priced seed is the least dilutive of the four on these numbers and the most expensive to document. That trade - legal cost and a real negotiation now against a larger share of the company later - is the actual decision, and it is usually made on the wrong axis.
• The note's interest is the smallest term in the comparison and the maturity date is the largest. A note that matures before the next round is likely to be renegotiated at a moment of weakness, and no cap protects against that.
• The post-money SAFE is the most dilutive at the same cap because it fixes the holder's percentage, which someone has to fund. The equivalent pre-money cap is the post-money cap less the amount raised on the instruments.
• None of these figures is a market observation. They are the arithmetic consequences of one set of stated terms, chosen so the four instruments can be compared on the same facts.

Source: Y Combinator SAFE templates and the NVCA model financing documents

The overhang that only becomes visible at the priced round

Instruments signed one at a time commit a total percentage that is never reported anywhere until the round closes and the closing cap table is built. At that point the conversion shares appear inside the pre-money count and the founders discover the arithmetic all at once.

Field	Value
Formula	Conversion shares as a fraction of the pre-money count = (S - FD)/S, where S is the solved pre-money count. Founders' ownership after the round = FD_founders/S * (1 - q)
Setup	The three-instrument stack: 2,250,000 raised on instruments against an 8,000,000-share starting count
Conversion shares	2,338,462 shares, which is 22.619 percent of the 10,338,462-share pre-money count
What the founders modelled	2,250,000 raised against an 8,000,000 pre-money-equivalent, which reads as roughly 22 percent
What the round delivers	Existing holders 61.905 percent after a round selling 20.000 percent
Where the difference goes	Nothing is lost - the instruments hold 18.095 percent between them, and the new investor still holds exactly R/POST

• The new investor's percentage is fixed by its cheque and the post-money valuation, so it is indifferent to how much converts. That leaves the founder as the only party with an economic reason to check the conversion arithmetic, and usually the only party without a model.
• The overhang is not a surprise in the sense of being hidden. Every input is in signed documents. It is a surprise in the sense that no single document states the total, and nobody is required to compute it before the round.
• The running total to maintain is the sum of I/cap for post-money instruments plus the fixed share counts of pre-money instruments. Two numbers, updated on each signature, and the whole thing is knowable in advance.
• Where the total is already uncomfortable, the fix is to raise the priced round earlier rather than to raise another instrument. Each additional instrument is priced against a cap set before the last one, so the cheapest capital available is also the most dilutive.

An MFN cascade across three instruments

Most favoured nation clauses apply to every MFN instrument outstanding, so a single cheap instrument reprices all of them at once. With three instruments the committed ownership is not the sum of the signed terms; it is the sum computed at the lowest cap any of them can elect.

Field	Value
Formula	Effective cap for every MFN holder = min over all qualifying instruments issued before conversion. Committed ownership = sum of I_k / effective cap
Setup	Instrument one 300,000, MFN only with no cap. Instrument two 500,000 at a 10,000,000 post-money cap. Instrument three 400,000 at a 6,000,000 post-money cap. All three carry MFN
On their own terms	Instrument two 5.000 percent, instrument three 6.667 percent, instrument one has no fixed percentage at all. Committed 11.667 percent
After the elections	All three elect the 6,000,000 cap: 5.000 + 8.333 + 6.667 = 20.000 percent
What the last 400,000 cost	It committed 6.667 percent on its own terms and 8.333 further percentage points by repricing the paper behind it
Effective blended cap	1,200,000 committed for 20.000 percent is a blended post-money cap of 6,000,000. The two instruments that did carry a cap average 8,222,222 weighted by amount, computed as (500,000*10,000,000 + 400,000*6,000,000)/900,000, and the third carried no cap at all to average in - so no weighted average of the headline terms produces the committed figure

• Total the MFN paper outstanding and reprice it at the proposed new cap before signing a lower one. The marginal cost of a small cheap instrument is its own dilution plus the repricing of everything behind it, and the second term is usually the larger.
• MFN is often the only economic term in a small early instrument, because a holder with no cap and no discount has nothing else. That makes it easy to concede and easy to forget, and it is exactly the term that compounds.
• Whether a later instrument is a qualifying one, and whether the election is exercisable continuously or only at a defined point, are drafting questions with large arithmetic consequences. The priced round itself is usually excluded.
• An uncapped MFN instrument is the strangest object in the stack: it has no committed percentage until someone else sets one for it. Its cost is entirely a function of the cheapest thing signed afterwards.

Source: Y Combinator SAFE (MFN variant)

A SAFE in a sale before any priced round

If the company is sold before a priced round, the instrument never converts at a cap. The holder elects between a cash claim for its money back and its as-converted share of the proceeds. The switchover is at an exit value exactly equal to the cap.

Field	Value
Formula	Holder receives max(I, (I/cap)*E) for a post-money instrument. The two are equal when E = cap
Setup	1,000,000 post-money SAFE at an 8,000,000 cap on a pre-round count of 8,000,000, so S = 9,142,857 and the holder's fixed share is 12.500 percent
At E = 4,000,000	Conversion pays 500,000; the cash claim pays 1,000,000. Cash claim elected
At E = 8,000,000	Both pay 1,000,000. Indifference, at E equal to the cap
At E = 20,000,000	Conversion pays 2,500,000; the cash claim pays 1,000,000. Conversion elected
What common receives at E = 4,000,000	4,000,000 less the 1,000,000 cash claim = 3,000,000 across 8,000,000 shares, or 0.3750 a share
Ranking	Behind all indebtedness, ahead of common. The instrument is not stock and does not vote

• The election is worth exactly max(0, I - (I/cap)*E), which is largest at the smallest exits. That makes an early acquisition offer below the cap a transfer from common to the instrument holders, and it is the outcome founders least often model.
• Some documents pay the purchase amount and some pay a multiple of it on a liquidity event. A 1x cash claim and a 1.5x cash claim are meaningfully different instruments in a small sale, and the term is short enough to be missed.
• The cash claim is not a liquidation preference in the charter sense, because no stock has been issued. It is a contractual payment obligation, which is why it ranks behind indebtedness rather than alongside the preferred.
• In a sale before any priced round the instruments are the whole capital structure other than debt. Run the waterfall on the instrument terms rather than assuming the common takes everything above the debt.

Source: Y Combinator SAFE (post-money), Liquidity Event provisions

Three pre-money SAFEs at the same cap deliver less than the sum of their parts

Post-money ownership is additive: the sum of I/cap is exactly what the holders end up with. Pre-money ownership is not, because each instrument's shares enlarge the denominator that the others are measured against. Summing I/cap across pre-money instruments overstates the result.

Field	Value
Formula	Pre-money instruments each take a fixed s_k = I_k/(cap_k/FD). Combined ownership before new money = sum of s_k / (FD + sum of s_k), which is strictly less than sum of I_k/cap_k
Setup	Three pre-money SAFEs of 500,000 each at an 8,000,000 cap, on FD = 8,000,000
Each instrument	CP = 1.0000, so 500,000 shares each and 1,500,000 in total
Combined ownership before new money	1,500,000/9,500,000 = 15.789 percent
Naive sum of I/cap	3 * 6.250 = 18.750 percent
Overstatement	2.961 percentage points, and it grows with the number of instruments
The same 1,500,000 as post-money instruments	Each takes exactly 6.250 percent, total 18.750 percent, and the founders fund the difference

• This is not a point in favour of pre-money instruments. It means the holders are worse off than their own arithmetic suggests, and that they cannot know their percentage until the round closes. Uncertainty for the holder is the price of the smaller total.
• It also means the sum of I/cap is the wrong running total for a pre-money stack. The right one is the sum of the fixed share counts, which is exact and is knowable on each signature.
• Mixing the two conventions produces the worst of both: the pre-money holders are diluted by the post-money holders and receive nothing in return, so the older paper is systematically worse off.
• The post-money cap that leaves a pre-money holder in the same position is the pre-money cap plus the total raised on the instruments. On these facts a 9,500,000 post-money cap issues the same 500,000 shares as an 8,000,000 pre-money cap.