A Simple Agreement for unborn Equity( SAFE) is a contractual agreement between a incipiency company and its investors. It exchanges the investor's investment for the right to favored shares in the incipiency company when the company raises a unborn round of backing. The SAFE sets out conditions and parameters for when and how the capital will convert into equity. Unlike a convertible note, a SAFE doesn't accrue interest or have a maturity date.
SAFE was introduced by Y Combinator( the world's preeminent incipiency accelerator) in late 2013. It was designed for early- stage startups and seed stage investors to raise capital snappily and simply. Since also, nearly all Y Combinator startups have used SAFE in early- stage fundraising. Outside of the Y Combinator community, the SAFE has come incredibly popular within the incipiency world due to its author-friendly nature, simplicity and effectiveness.
Y Combinator has drafted four performances of the SAFE. They are
SAFE Valuation cap, no reduction
SAFE reduction, no valuation cap
SAFE Valuation cap and reduction
SAFE MFN, No valuation cap, no reduction
Note that in the fall of 2021, Y Combinator removed number three, the SAFE Valuation cap and reduction from their website( without explanation). still, it remains a popular interpretation of SAFE. The strongboxes are easy to use off the shelf with minimum correction. still, investors and authors occasionally amend terms in strongboxes with the guidance of counsel to produce their own variations.
High Resolution Fundraising : Benefits of SAFE Agreements for Startups
SAFE has been ate by the incipiency community for several reasons.
● Fast and easy — strongboxes published on Y Combinator’s website are around six runners long. They're fairly simple and straightforward with smaller variables to understand and negotiate. This saves time in concession, which allows the sale to move on in a briskly and more effective manner. It also saves associated costs in relation to the sale.
● No interest payment and maturity date — strongboxes remove features in convertible notes that give incipiency authors headaches, similar as interest payments and maturity dates. Using strongboxes mean authors no longer have to worry about keeping track of interest or asking investors for extensions when maturity dates approach. This allows authors to more concentrate on growing the company.
● No prepayment of top — strongboxes are author-friendly and put no obligation on the authors to repay the investment if the SAFE no way converts into security. While this can be seen as a negative as the investors could be left with nothing, utmost professional seed stage investors understand the pitfalls of investing in early- stage startups. still, SAFE isn't suitable for investors who anticipate prepayment of an investment should it fail.
● High- resolution fundraising — A typical round of backing requires a lot of collaboration to get investors aligned, subscribing documents and wiring plutocrat on a single close date. With the SAFE, startups can close with an investor as soon as both parties are ready to subscribe and the investor is ready to wire plutocrat. Y Combinator author Paul Graham calls this high- resolution fundraising.
pitfalls of SAFE
Despite all the convenience bandied over, SAFE is occasionally not so simple or safe.
● No equity stakes Being a SAFE investor doesn't entitle one to the rights of a stockholder. strongboxes aren't equity stakes in the company, so SAFE investors aren't defended under state commercial law or civil securities law. rather, SAFE investors are entitled to a unborn equity stage only if certain driving events occur. However, a SAFE investor can be left with nothing, If the driving event no way occurs.
● Too easy — Ironically, the main point of the SAFE — its simplicity is also a bug. Because it’s come so easy for authors to raise plutocrat on strongboxes, numerous authors raise a bunch of plutocrat without understanding the impact on the cap table. also they've a rude awakening when the strongboxes convert, and they realize how important of their company they ’ve given away and how important it has adulterated them.
strongboxes Convert Into Preferred Stock in Equity Financing
The SAFE converts into equity at the coming round of backing where the company sells favored stock at a fixed valuation. Unlike good backing in the convertible note, there's no minimal size of the round.
Upon an equity backing, the capital that the SAFE investor invested converts into shares of favored stock in the company. The shares will have the exact same preferences, rights and restrictions as the favored shares of the new investors in the equity backing( new investors). Authors should flash back that when they're negotiating the terms with the investors in an equity backing, they're negotiating for the shares of the new investors as well as the SAFE investors. The number of favored shares that the SAFE will convert into depends on whether there's a reduction and/ or a cap.
SAFE Reduction
The reduction in a SAFE is used as a medium to address the advanced threat of investment that SAFE investors take when investing in an early- stage incipiency. It's a reduction off the price per share paid by new investors in the equity backing. The reduction may range anywhere between 5 to 30, with 20 being the norm.
For illustration, if the SAFE investors enjoy a 20 reduction and the investors in the posterior round of backing( new investors) purchase favored shares at$ 1 per share, the SAFE investors would only pay$0.80 per share. The advanced the reduction rate, the further equity SAFE investors would admit for their investment.
The reduction rate is easily stated in bold at the top of the agreement. It's written as 100 lower than the reduction rate; for illustration, a 20 reduction is written as 80, and a 10 reduction is written as 90.
Occasionally the reduction alone may not be sufficient in guarding an early investor’s interest. therefore, some investors will use a valuation cap in SAFE to cover their interests in circumstances where the company is growing a lot more fleetly than anticipated.
Valuation Cap
still, it’s generally the most heavily negotiated term, If the SAFE has a valuation cap. What's a valuation cap, and why does it admit so important attention? A valuation cap is the loftiest valuation at which the quantum invested in the SAFE would be converted into shares. It's the maximum valuation that the SAFE investor will pay, anyhow of the factual valuation of the equity backing.
For illustration, if the SAFE valuation cap is$ 10 million and the new investors are investing in the company at a$ 20 million valuation, also SAFE investors will be paying partial price for their shares relative to the new investors.( They can buy doubly as numerous shares for their plutocrat as the new investors.)
Authors should always keep unborn rounds in mind when they set a cap on their SAFE. The SAFE investors are taking a threat because they're investing before in the incipiency when there's increased query, so they should be awarded for that early investment. But you presumably don’t want them to be buying at half price of the new investors. However, authors threat giving up too important equity to the SAFE investors and lacing them self in the process, If the cap is too low.
What’s More for Authors reduction or Cap?
Generally, the ideal situation for authors is for the SAFE to be uncapped and blinked . This rewards the convertible note investor for taking on early threat. It also avoids the challenge of assigning an arbitrary value to the company, which could be too high or too low.
Some investors contend they will" no way " invest in a SAFE without a valuation cap. still, the outgrowth depends on the logrolling power of the parties involved. At the pre-seed stage, an uncapped SAFE could suggest the company is seductive and has some influence in accommodations, which could help draw in better investors for after rounds of equity backing.
still, not all early- stage startups have investors eagerly staying to invest. When negotiating a valuation cap, authors should insure that it's set at a reasonable position — immaculately advanced than what the company could achieve if it were to do a priced equity round of backing.
Conclusion
A solid understanding of these terms will help authors unite with their legal counsels to secure an profitable deal for themselves and their platoon. Check out this videotape to learn further. For a deeper dive, read this companion.