Everything You Wanted to Know About SAFE (Simple Agreement for Future Equity)

Equity financing can be complicated for early stage startups. Traditional equity financing like convertible notes come with complex legal terms and negotiations. Enter the SAFE – Simple Agreement for Future Equity. The SAFE framework aims to simplify early stage equity financing.

In this comprehensive guide, we’ll cover everything you need to know about the SAFE:

What is a SAFE and how does it work?

A SAFE stands for Simple Agreement for Future Equity. It allows startups to raise capital without setting a valuation upfront. With a SAFE, the startup gets capital now in exchange for giving the investors equity later when a priced round of financing happens.

Let’s break this down:

• Simple agreement – The SAFE document is relatively short and straightforward compared to traditional financing documents. This makes the legal process faster and cheaper.
• Future equity – Instead of getting equity now, investors get the right to future equity. The startup sets the valuation and issues equity in a future priced round.
• No valuation – Valuation is often a pain point in early stage financing. SAFE lets startups raise funds without agreeing on a valuation upfront.

Essentially, a SAFE allows startups to delay the valuation conversation until a future priced round. This helps startups test their ideas without getting bogged down in legal complexities of a priced round.

What are the benefits of using a SAFE?

There are several compelling benefits of using a SAFE for early stage financing:

• Simple and fast – SAFE docs are straightforward, usually around 10 pages. This makes the financing process much faster and cheaper than traditional equity rounds.
• No valuation required – Valuing pre-revenue startups can be challenging. SAFE lets founders raise funds without hard valuation conversations.
• Aligns incentives – SAFE holders benefit when the company raises its next round at a higher valuation. This incentivizes investors to add value and help the company grow.
• Easy to understand – SAFE is easier to grasp than complex equity instruments for founders and investors alike. This improves transparency and trust.
• Standardized docs – Using standardized SAFE docs vs custom convertible notes simplifies negotiations.
• Conversion flexibility – Details of SAFE conversion to equity can be tailored to company-investor needs.

For early stage startups, SAFE offers a faster, simpler way to raise risk capital without cumbersome term sheets and legal bills.

What are the downsides of using a SAFE?

However, SAFE financing isn’t ideal for every startup situation. Here are some potential downsides to consider:

• No immediate equity – Investors don’t get equity right away. For some investors, this may be a blocking point.
• Potentially diluted conversion – If the startup raises the next round at a lower valuation, SAFE holders get less equity compared to a capped convertible note.
• Less flexibility – SAFE terms are quite standardized. Companies have less room to tailor the agreement.
• No debt component – SAFE does not accrue interest like a convertible note. This reduces investor upside.
• Caps matter – Valuation caps become very important in SAFEs to protect against dilution. However, agreeing on caps can require negotiations.
• Less investor protection – SAFEs lack maturity dates and repayment options common in convertible notes. This exposes investors to more risk.

So while SAFE offers advantages like speed and simplicity, traditional convertible notes may be a better fit for startups wanting more control or investor protections.

Origins of the SAFE – how it came about

The SAFE was created in 2013 by Y Combinator (YC) – the influential startup accelerator.

YC wanted a standardized, simple financing document for its early-stage companies to use. At the time, most YC startups used convertible notes which required lengthy negotiations.

John Fogg and YC believed startups needed an easier option without the complexities of price and control.

The SAFE was born out of this need for a simplified early-stage funding document. YC published a standard SAFE template in 2013. Since then, SAFE has seen wide adoption by startups and investors.

However, it is important to note that SAFE is not a YC-exclusive instrument. Any early-stage startup can use it for fundraising.

Key terms in a SAFE agreement

While simpler than traditional financing documents, SAFEs still contain legal and financial terms that founders need to understand:

Investment amount – The total funds being invested by the SAFE holder into the startup.

Discount rate – This determines the discounted price at which SAFE converts into equity in the next round. The typical discount is 20%.

Valuation cap – The maximum pre-money valuation at which the SAFE will convert in the next round. This caps dilution for SAFE holders.

Right to future equity – The core of the SAFE. Gives investors the right to get equity shares in the future based on the next round’s valuation and discount rate.

Pro rata rights – Gives SAFE holders the right to participate in future financing rounds to maintain ownership percentage.

Equity financing – Defines a future “priced round” where SAFE converts. Ensures SAFE doesn’t accidentally convert during safe financings.

Liquidity terms – Optional terms allowing SAFE to be converted to equity outside of a priced round, like after a time period or acquisition.

Dissolution terms – Terms governing what happens if the company shuts down before the SAFE converts.

SAFE vs Convertible Notes – How do they compare?

Convertible notes have been the dominant form of early-stage financing for a long time. But the SAFE is giving convertible notes serious competition lately.

Let’s compare the two financing instruments:

Priyanka

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Priyanka transitioned from being a trendsetting fashionista to an influential business blogger. With an innate passion for style and an astute entrepreneurial mindset, Priyanka carved her own path in the digital landscape, captivating audiences with her unique blend of fashion-forward insights and astute business acumen. Through her posts, she shares her expertise on emerging trends, fashion industry analysis, and valuable advice for aspiring entrepreneurs.