A Simple Agreement for Future Equity (SAFE) is an agreement between a company and an investor, in which, in exchange for a payment by the investor to the company, the investor receives the right to receive equity (shares) in the company when a pre-agreed trigger event occurs. The trigger event could be a future equity fundraising event or a series of events by the company for the principal purposes of raising capital.
"A SAFE allows a company to delay placing a value on itself. This is particularly attractive for start-up companies that have not had time to show their product sales and/or receive revenue."
Unlike a convertible note, a SAFE is not a loan, as it does not include a debt element nor a fixed maturity date, and interest is not charged. It is essentially a promise that the company will issue shares to the investor in the future on agreed terms.
A SAFE commonly deals with the following key terms:
Investment amount and payment date - the amount of funding the investor will pay to the company, and when it is due to be paid;
The trigger event - triggers the issue of equity (shares) to the investor. This usually specifies the minimum value of the equity fundraising event, and the type of shares issued to trigger conversion;
Valuation cap - sets the valuation method to determine the price per share the investor will pay when their payment converts into equity. This can be either a pre-or post-money valuation (see below) and may include a cap or ceiling price;
Discount rate - specifies the discount (if any) the investor receives on the price that other investors pay in the equity fundraising event; and
Permitted Purpose - the permitted purpose for which the Company is allowed to use the investors' payment.
Trigger Event
The trigger event is typically tied to a subsequent financing round, such as the issue of preferred shares or a specified amount of funding raised by the start-up. Trigger events may include:
a fundraising event, where the issues shares to its investors (i.e. equity financing); or
the company being sold or offering its shares via an Initial Public Offering (IPO) (i.e. an exit event).
Valuation
A SAFE allows a company to delay placing a value on itself. This is particularly attractive for start-up companies that have not had time to show their product sales and/or receive revenue. A SAFE will set a future valuation method to determine the price per share the investor will pay when their payment converts into equity.
Pre-money and post-money valuations are two ways of framing the valuation of a company - at different points in time:
pre-money is the valuation immediately before the company receives an investment; and
post-money is the valuation immediately after the investment is made (this valuation includes the investment).
For example, a company raising $2 million at an $8 million pre-money valuation is raising $2 million at a $10 million post-money valuation.
"SAFEs are a transparent way to get money into a start-up fast, giving early-stage businesses the foundation and support to get moving and making money."
- Pre-money valuation
A pre-money valuation uses a conversion price per share based on the company's fully diluted share count excluding shares issuable to convertible instruments (e.g. this and other SAFEs and convertible notes).
An investor (and the founders) only know the exact ownership breakdown of the company at the closing of the capital raising event. A pre-money SAFE is generally less desirable for investors (and more desirable for founders), as SAFEs (and other convertible instruments) dilute each others ownership percentage, rather than the founders.
- Post-money valuation
A post-money valuation uses a conversion price per share based on the company's fully diluted share count including shares issuable to convertible instruments (e.g. this and other SAFEs and convertible notes).
Using a post-money valuation, an investor is able to "lock in" the percentage of the company they will own when the SAFE converts into shares. A post-money SAFE is generally more desirable for investors, as each investor can lock in the percentage of the company they will receive, and less desirable for the founders, as their ownership is diluted by the SAFE owners.
- Valuation Cap
Often a valuation cap will be set. A valuation cap sets the ceiling on the price per share the investor will pay when their payment converts into equity.
For example, if the valuation cap is set at $1,000,000 and the company is valued at $1,400,000 at the subsequent equity fundraising event, the investor's payment will convert into equity at the $1,000,000 valuation cap.
- Discount
The investor may also receive a discount on the price that other investors in the equity fundraising event pay, in recognition of their early financial support.
For example, if an investor pays $1.00 per share and the SAFE specifies an 85.00% discount rate, the investor's payment will convert at $0.85 per share.
- Most Favourable Nation (MFN)
If included, an MFN clause allows the investor to elect to inherit more favorable terms that are offered to any subsequent investors following the investor’s investment and prior to an equity fundraising event.
Pros and Cons of a SAFE
SAFEs are a transparent way to get money into a start-up fast, giving early-stage businesses the foundation and support to get moving and making money. This in the end benefits both founder and investor. SAFEs are generally simpler and quicker to execute compared to convertible notes. They have fewer terms and conditions, making the fundraising process faster and more streamlined.
However, SAFEs can be especially risky for the investor because they don’t own anything at the time they providing the funding to the Company. In the event of a liquidation or wind-up, the investor may get nothing if the SAFE hasn’t already converted.
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