A SAFE is a form of convertible security. A SAFE isn’t debt; it’s a promise to issue future equity once certain terms are met.
SAFEs are a simpler alternative to convertible notes for early-stage startups looking to structure investments without interest rates, redemption rights, or maturity dates.
And to simplify things further, we’re sharing an Open Source VC SAFE template!
What is a SAFE?
A Simple Agreement for Future Equity (SAFE) is a flexible agreement between an investor and a startup where in exchange for upfront money, the investor gains a contractual right to convert that amount into shares in the future when a pre-agreed trigger event occurs.
Early-stage startups use SAFEs to acquire money quickly and skip the typically time-consuming process of determining the valuation and carrying out comprehensive due diligence.
What is a trigger event?
A trigger event can include:
- A priced equity financing round
- An exit event, such as an IPO or acquisition.
Following a trigger event, the investment amount will convert into shares in the startup. In the case of a financing round, the SAFE will convert into the class of shares being issued in the round (e.g. Seed Preference Shares), and in an exit event, the SAFE will convert into ordinary shares.
The number of shares the investor receives depends on the initial cash payment amount, and the share price of the priced equity round or exit event. A startup may also agree to include a discount rate or valuation cap, which would apply to the relevant trigger event. This generally means that the investor receives their shares at a discounted price to the trigger event (in exchange for assuming additional uncertainty and risk in entering into the SAFE).
There may be scenarios where triggers aren’t activated, and the SAFE doesn't convert. For example, if your startup makes enough money that you never need to raise capital again, and you don’t get acquired by another company, then there may never be a trigger event for the SAFE conversion. Conversely, if your startup becomes, or is likely to become, insolvent, then SAFE investors are usually entitled to be reimbursed their investment amount.
SAFEs contain a few primary terms that determine how they convert to company shares:
A valuation cap is an agreed maximum value of your startup, which applies when a SAFE converts. When a trigger event occurs, the investor’s subscription amount will convert into equity relative to the valuation cap, even if your startup's valuation is higher than the cap.
When issuing a SAFE, the main thing to consider in terms of the valuation cap is the proximity to your startup’s next raise. If your startup is looking to raise in 6 months to 1 year’s time, the valuation cap will be relatively close to the value of your startup at the date of the SAFE investment. The valuation cap will likely be higher if the next raise is 1+ years away.
Startups may also include a discount rate in the SAFE. The discount rate applies to the price per share in the relevant trigger event. The investor’s subscription amount will convert at the trigger event’s price, less the discount rate. Discount rates are agreed and fixed in the SAFE – usually at 20% or less.
Most Favoured Nation
If your startup issues numerous rounds of SAFEs, a most favoured nation clause (MFN) causes any more favourable terms included in subsequent SAFEs (e.g. valuation cap, discount rate etc.) to automatically apply to any investors’ SAFE which includes an MFN. The MFN falls away once a SAFE has converted.
Valuation cap and discount scenarios
Valuation caps and discounts are commonly used in three different ways:
Valuation cap, no discount
In this scenario, the investor can convert their SAFE into shares based on the valuation cap. The valuation cap is the maximum possible valuation of a startup, even when the actual value of the startup in subsequent raises or an exit event is higher than the value specified in the valuation cap.
Discount, no valuation Cap
In this scenario, the investor’s SAFE converts into shares during a priced equity financing round or an exit event, at a discount to the relevant price per share in the respective trigger event.
Valuation cap and a discount
Startups often include both a valuation cap and a discount rate in SAFEs. The SAFE works by applying the process (e.g. the discount rate, or valuation cap), which results in the investor receiving the greatest number of shares.
Pro rata rights
Pro rata rights allow investors to invest extra funds to maintain their percentage of ownership during future equity financings. These rights are generally only granted to investors after the SAFE has converted into preferred shares of the company during an equity financing round. In some circumstances, startups will grant special pro rata rights to investors while they hold a SAFE.
An investor with pro rata rights isn’t required to invest anything into your next round, and founders should assume they have to earn investors’ pro rata investments in subsequent rounds. It’s also worth discussing with investors whether they hold reserves for each of their investments to take their pro rata.
Pro rata rights can be calculated in three different ways:
- Percentage basis: Investors have the right to maintain their ownership percentage by continuing to invest more capital in subsequent rounds. This is the most common scenario.
- Dollar-for-dollar basis: Investors have the right to invest an equal amount or lesser than what they invested before. This scenario is much less common.
- Fixed-sum basis: Investors maintain the right to continuously invest an amount as agreed upon that is decoupled from the investment amount. This approach is not widely used.
Pre-money and post-money
A pre-money SAFE does not include the current SAFE in the company capitalisation (or any other SAFEs or convertible instruments). The company capitalisation is calculated before the SAFE converts, making it difficult to precisely calculate how much ownership the founder, team and investors will have when the SAFE converts.
On the other hand, post-money SAFEs include the current SAFE (as well as any other SAFEs or convertible instruments) in a company’s capitalisation, providing the company’s fully diluted capitalisation. Post-money SAFEs allow you to calculate specific ownership stakes and how much dilution has occurred with each SAFE.
Advantages of a SAFEs
- Easy to create and implement
As there is no need to agree on a pre-money valuation, SAFEs are quick and easy to negotiate. Founders can close with an investor as soon as both parties are ready to sign (and the investor is ready to transfer the funds), rather than coordinating a single close with multiple investors simultaneously.
- No interest
SAFEs don’t accrue interest, and founders can avoid the complexity of converting interest into equity.
- No debt
SAFEs are an equity, not a debt, and therefore don’t create the threat of insolvency for a startup.
- No maturity or end date
SAFEs can be held in perpetuity. There is no fixed date for when the startup must repay the SAFE, taking the pressure off founders and their timeline for a trigger event (e.g. a priced equity financing round).
Disadvantages of SAFEs
- Dilution implications
Founders can fall into the trap of not doing the basic dilution calculations associated with their ownership stake when the SAFE converts into equity. This results in founders owning less of their startup’s equity than they thought they did when an equity round is eventually priced.
- Ignoring the signals
Founders who cannot find a lead investor to price the round on the valuation and the terms they’re after, and instead choose to use a SAFE, may be ignoring the implicit message of the predicament they’re in.
This article does not constitute legal advice, and the SAFE document is only a template. You should always seek legal advice if you’re considering using this template.