“Next year there will be a lot of SAFEs converting; usually they’d be based on an equity round, but now they’re going to convert just based on a maturity date, and it will do so at a set price [if the company does not raise again].”
Problem around the corner
Mr Heine said the valuations being set in this year’s clutch of SAFEs were typically flat, but with provisions for it to convert at the lower of the set price, or at a discount to a future equity round.
Maturity dates put pressure on founders to complete their next raise before that time, if they believe they can raise at a higher valuation. If a founder commences the process, needs the capital, but can’t find investors willing to invest at a higher price, this opens up the real problem of 2023.
“The big scary thing hovering over us is if the next round is a down round. That is a real catastrophe, so let’s hope it doesn’t happen to founders,” Mr Heine said.
“There are a lot of ifs and buts … but the conversion [at a maturity date] would not be a totally negative outcome for founders because they can predict what the dilution will be now, and consider that they’ve already given it away.
“But if there is a down round, a lot of investors will also have anti-dilution mechanisms, which will mean the round will adversely affect the founder a lot more than previous investors and that will have a really big impact.”
For companies around the Series A stage, most SAFEs being raised are between $1 million to $3 million, and most are designed to extend a company’s runway by 12 to 18 months.
Bigger companies to be hit harder
With so many bridging rounds raised this year, start-ups will need to have grown into their previous valuations to avoid down rounds in 2023.
This will have a greater effect on larger companies, which may have already had valuations marked down on their investors’ books – such as Canva.
Music licensing platform Songtradr is tapping the market for fresh funding and has reduced its valuation by 17 per cent to $US425 million, compared to March when it kicked off a raise that was later scrapped.
Buildxact also took a very minor haircut to its valuation when it went back to investors in early September to raise $5 million of additional capital, at a post-money valuation of $121.3 million, compared to its valuation of $125 million in January.
But, for the most part, companies have deferred setting a new valuation this year, according to Mr Heine.
Ignition Lane founder Gavin Appel said founders were making decisions that ensured the survival of their companies, but investors had a responsibility to act in the best interests of start-ups.
“Their key responsibility is not to run out of cash,” he said.
“But this is a long-term game. It’s important for both founders and investors to recognise that founders need to be incentivised on the upside to maximise shareholder returns in the long run – do they have enough skin in the game to shoot for the stars and deliver outsized returns?
“Founders may be diluting more than they would have last year, or the year before, and that might not be a good thing for investors either.”
