Fund | 3 October 2017

What is a SAFE?

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A SAFE is a “Simple Agreement for Future Equity”. It is an agreement between a company and an investor: the investor invests money in the company and, in exchange, receives the right to have its investment amount applied towards the purchase of shares in a future equity round when it occurs.

Where did it come from?

Y Combinator (commonly known as “YC”, a US seed accelerator for startups) developed a SAFE and made it open source (i.e. it was made publicly available to use and develop further). It was designed as a replacement to convertible notes (a form of short-term debt that converts to equity): a SAFE achieves the same purpose as a convertible note but without the accrual of interest or mandatory repayment (i.e. a SAFE is not a debt instrument). The popularity of SAFEs in the world’s leading venture capital centres has been increasing rapidly and they are more founder-friendly than convertible notes.

How does it work and why should I use one?

The two main elements set out in a SAFE are the valuation cap agreed between the investor and the company (see “Cap on the price” below) and the investment amount to be paid by the investor to the company (typically on the date the SAFE is signed). The SAFE is listed in the company’s capitalisation table (in the same way as any other convertible security). Nothing else happens until the occurrence of the events specified in the SAFE. When the company undertakes an equity funding round, an outstanding SAFE is triggered and will convert into preferred shares. Typically, the SAFE is triggered regardless of the amount that the company raises through its next equity funding round.

There are several benefits in using a SAFE:

• Raise money only when you need to: Companies can raise money using SAFEs with incrementally higher valuations as the value of the company grows. So using a SAFE may be an attractive method for a startup with a prolonged research and development phase. More traditional capital raising methods involve selling a large portion of the company at an early point in the life cycle. The low valuation at this point results in a relatively small amount of cash being raised and also significantly dilutes the founders’ ownership. This process of selling equity in a “priced round” also requires multiple documents and amendments to the company’s articles of association, involving time and cost.

• Cap on the price: Investors know the maximum valuation of the company at which they will ultimately invest. That investment will convert to shares in the company’s next equity funding round at a price no higher than the valuation cap specified in the SAFE.

• Legal costs: A SAFE is a short document and its key terms and operation are understood in the market. New companies using a SAFE should enjoy the lack of negotiation required with their investors – and can view any major push back from a potential investor as a red flag that perhaps the investor doesn’t make regular investments in startups.

• Choices on sale of the company: An investor has choices: if an equity funding round has not been completed (i.e. the SAFE has not yet converted) and the company is sold or merged (i.e. a change of control transaction), the investor is entitled to either (a) the amount they would have received if the SAFE converted at the valuation cap or (b) the return of their investment.

• Control and dividends: An investor does not usually have any management rights or receive any dividends until the SAFE converts into shares.

Why would I use a SAFE instead of a convertible note?

A SAFE has two key advantages over a convertible note:

Interest Rate: SAFEs are not debt so the company does not pay interest to the investor. This isn’t an issue for most investors as they aren’t looking for an annual interest payment when they make a seed investment in a startup company.

• Maturity Date: A SAFE does not have a maturity date so the company is not required to repay the money invested by the investor. Convertible notes often have a maturity date of one year.

What is market?

The basic concept of the SAFE is accepted in the market, but its terms can vary. We typically see the SAFE with a cap and  a discount: in our experience only about three-quarters of SAFEs used have a discount. There are also instances of hybrid SAFEs that include certain elements of a convertible loan note, such as having a mandatory conversion date (please see What is a KISS? for more information).

What else could I use?

Shortly after the SAFE was created by Y Combinator, 500 Startups developed their own version: the KISS (“Keep It Simple Security”).

If you’d like to know more, please see FUND my business for information on convertible loan notes, KISSes and financing generally.


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