A Easy Settlement for Future Fairness (SAFE) is a contractual settlement between a startup firm and its buyers. It exchanges the investor’s funding for the appropriate to most popular shares within the startup firm when the corporate raises a future spherical of funding. The SAFE units out circumstances and parameters for when and the way the capital will convert into fairness. In contrast to a convertible notice, a SAFE doesn’t accrue curiosity or have a maturity date.

SAFE was launched by Y Combinator (the world’s preeminent startup accelerator) in late 2013. It was designed for early-stage startups and seed stage buyers to lift capital rapidly and easily. Since then, nearly all Y Combinator startups have used SAFE in early-stage fundraising. Exterior of the Y Combinator neighborhood, the SAFE has turn into extremely fashionable throughout the startup world as a consequence of its founder-friendly nature, simplicity and effectivity.

Y Combinator has drafted 4 variations of the SAFE. They’re:

1. SAFE: Valuation cap, no low cost
2. SAFE: Low cost, no valuation cap
3. SAFE: Valuation cap and low cost
4. SAFE: MFN, No valuation cap, no low cost

Be aware that within the fall of 2021, Y Combinator eliminated quantity three, the SAFE: Valuation cap and low cost from their web site (with out rationalization). Nonetheless, it stays a preferred model of SAFE. The SAFEs are straightforward to make use of off the shelf with minimal modification. Nonetheless, buyers and founders generally amend phrases in SAFEs with the steerage of counsel to create their very own variations.

Excessive Decision Fundraising: Advantages of SAFE Agreements for Startups

SAFE has been welcomed by the startup neighborhood for a number of causes.

● Quick and simple—SAFEs printed on Y Combinator’s web site are round six pages lengthy. They’re pretty easy and simple with fewer variables to grasp and negotiate. This protects time in negotiation, which permits the transaction to maneuver alongside in a quicker and extra environment friendly method. It additionally saves related prices in relation to the transaction.

● No curiosity fee and maturity date—SAFEs take away options in convertible notes that give startup founders complications, comparable to curiosity funds and maturity dates. Utilizing SAFEs imply founders not have to fret about retaining observe of curiosity or asking buyers for extensions when maturity dates strategy. This enables founders to higher concentrate on rising the corporate.

● No compensation of principal—SAFEs are founder-friendly and impose no obligation on the founders to repay the funding if the SAFE by no means converts into safety. Whereas this may be seen as a unfavourable because the buyers might be left with nothing, {most professional} seed stage buyers perceive the dangers of investing in early-stage startups. Nonetheless, SAFE isn’t appropriate for buyers who count on compensation of an funding ought to it fail.

● Excessive-resolution fundraising—A typical spherical of funding requires quite a lot of coordination to get buyers aligned, signing paperwork and wiring cash on a single shut date. With the SAFE, startups can shut with an investor as quickly as each events are able to signal and the investor is able to wire cash. Y Combinator founder Paul Graham calls this high-resolution fundraising.

Dangers of SAFE

Regardless of all of the comfort mentioned above, SAFE is usually not so easy or secure.

● No fairness stakes—Being a SAFE investor doesn’t entitle one to the rights of a stockholder. SAFEs usually are not fairness stakes within the firm, so SAFE buyers usually are not protected beneath state company legislation or federal securities legislation. As an alternative, SAFE buyers are entitled to a future fairness stage provided that sure triggering occasions happen. If the triggering occasion by no means happens, a SAFE investor might be left with nothing.

● Too straightforward—Paradoxically, the principle characteristic of the SAFE—its simplicity—can be a bug. As a result of it’s turn into really easy for founders to lift cash on SAFEs, many founders elevate a bunch of cash with out understanding the influence on the cap desk. Then they’ve a impolite awakening when the SAFEs convert, they usually understand how a lot of their firm they’ve given away and the way a lot it has diluted them.

SAFEs Convert Into Most well-liked Inventory in Fairness Financing

The SAFE converts into fairness on the subsequent spherical of funding the place the corporate sells most popular inventory at a hard and fast valuation. In contrast to certified financing within the convertible notice, there is no such thing as a minimal measurement of the spherical.

Upon an fairness financing, the capital that the SAFE investor invested converts into shares of most popular inventory within the firm. The shares could have the very same preferences, rights and restrictions as the popular shares of the brand new buyers within the fairness financing (new buyers). Founders ought to keep in mind that when they’re negotiating the phrases with the buyers in an fairness financing, they’re negotiating for the shares of the brand new buyers in addition to the SAFE buyers. The variety of most popular shares that the SAFE will convert into will depend on whether or not there’s a low cost and/or a cap.

SAFE Low cost

The low cost in a SAFE is used as a mechanism to deal with the upper threat of funding that SAFE buyers take when investing in an early-stage startup. It’s a low cost off the value per share paid by new buyers within the fairness financing. The low cost might vary anyplace between 5% to 30%, with 20% being the norm.

For instance, if the SAFE buyers take pleasure in a 20% low cost and the buyers within the subsequent spherical of financing (new buyers) buy most popular shares at $1 per share, the SAFE buyers would solely pay $0.80 per share. The upper the low cost charge, the extra fairness SAFE buyers would obtain for his or her funding.

The low cost charge is clearly acknowledged in daring on the high of the settlement. It’s written as 100% lower than the low cost charge; for instance, a 20% low cost is written as 80%, and a ten% low cost is written as 90%.

Typically the low cost alone might not be ample in defending an early investor’s curiosity. Thus, some buyers will use a valuation cap in SAFE to guard their pursuits in circumstances the place the corporate is rising much more quickly than anticipated.

Valuation Cap

If the SAFE has a valuation cap, it’s usually probably the most closely negotiated time period. What’s a valuation cap, and why does it obtain a lot consideration? A valuation cap is the very best valuation at which the quantity invested within the SAFE could be transformed into shares. It’s the most valuation that the SAFE investor pays, whatever the precise valuation of the fairness financing.

For instance, if the SAFE valuation cap is $10 million and the brand new buyers are investing within the firm at a $20 million valuation, then SAFE buyers can be paying half worth for his or her shares relative to the brand new buyers. (They’ll purchase twice as many shares for his or her cash as the brand new buyers.)

Founders ought to at all times hold future rounds in thoughts once they set a cap on their SAFE. The SAFE buyers are taking a threat as a result of they’re investing earlier within the startup when there’s elevated uncertainty, so they need to be rewarded for that early funding. However you in all probability don’t need them to be shopping for at half worth of the brand new buyers. If the cap is simply too low, founders threat giving up an excessive amount of fairness to the SAFE buyers and diluting themself within the course of.

What’s Higher for Founders: Low cost or Cap?

Usually, the best state of affairs for founders is for the SAFE to be uncapped and discounted. This rewards the convertible notice investor for taking over early threat. It additionally avoids the problem of assigning an arbitrary worth to the corporate, which might be too excessive or too low.

Some buyers insist they may “by no means” spend money on a SAFE with no valuation cap. Nonetheless, the end result will depend on the bargaining energy of the events concerned. On the pre-seed stage, an uncapped SAFE might recommend the corporate is engaging and has some leverage in negotiations, which might assist attract higher buyers for later rounds of fairness financing.

Nonetheless, not all early-stage startups have buyers eagerly ready to speculate. When negotiating a valuation cap, founders ought to be sure that it’s set at an inexpensive degree—ideally greater than what the corporate might obtain if it have been to do a priced fairness spherical of financing.

Conclusion

A stable understanding of those phrases will assist founders collaborate with their authorized advisors to safe an advantageous deal for themselves and their group. Try this video to be taught extra. For a deeper dive, learn this information.