If you’re an entrepreneur seeking capital for your startup, then you’ve likely already heard about the “Simple Agreement for Future Equity” or “SAFE.”
Engineered by Silicon Valley accelerator Y Combinator, SAFEs are designed to provide a simple, clear, and fast way to legally raise capital without interest rates and maturity dates. That’s true, at least in theory!
So, what should your startup or investors know before signing a SAFE? Below are some thoughts to help you get smart on these new investment vehicles.
A SAFE is considered a “convertible security” that allows an investor to provide a cash loan in return for equity at a future priced round. SAFEs are attractive to investors for two reasons. First, it provides “discount” and “valuation cap” provisions when it comes time to convert. Second, it includes early exit payback provisions whereby the full amount of the SAFE note can be paid to the investor in the event of an acquisition or change in control.
Thinking of doing a SAFE investment or want to learn more? Below are 5 additional points to increase your knowledge of SAFEs. You can also contact us at firstname.lastname@example.org to learn more about how SAFEs can help secure new investment without a ton of paperwork and (legal fees).
1. SAFEs are for Corporations.
You should be structured as a legal corporation to offer SAFEs. The SAFE issues your investor a special class of “SAFE stock” come conversion time. A corporation is generally the only type of legal entity that can issue shares of stock, providing ownership in the company, voting rights, and dividends. If your business is already organized as a limited liability corporation or LLC then you may not be eligible to offer SAFEs because LLCs have “membership interests” as opposed to “shares.” Check your state’s laws or contact us to see if it’s possible for your entity to issue a SAFE.
2. SAFEs are still relatively new to the investment game.
SAFEs are still relatively new, even to experienced investors. Many investors, and even some corporate finance attorneys, are still uncomfortable with signing SAFEs. For example, many are more comfortable with a “convertible note.” Keep in mind, a SAFE is a simpler alternative to a convertible note, but a convertible note may still be a more attractive option to an investor because it’s more established and offers unique favorable terms. Convertible notes may include interest and maturity rates. SAFEs do not. If your potential investor is not well versed in the SAFE structure, you could engage an attorney to explain it simply or send them this SAFE Primer to review. Good luck getting them to read it!
3. SAFEs require some negotiation skills.
While SAFEs are designed as investment templates, some skillful negotiation is still required. SAFE notes are generally less flexible than convertible notes. As previously mentioned, SAFEs do not include interest rates or maturity dates. In turn, your investor may insist on a lower value capitalization or a higher discount rate. A lower value capitalization rate and higher discount rate increase the likelihood that your investor is able to purchase more shares once conversation time arrives. As the issuer, you may want to negotiate these rates, so you do not end up giving away more equity in your company than desired. On the other hand, as a first-time startup in need of capital, you may not have a ton of leverage to negotiate favorable rates.
4. SAFEs work best with cap tables.
Because most SAFEs use a valuation cap to determine the appropriate price per share, founders issuing SAFEs should understand basic “cap table” math. A basic capitalization or “cap table” is usually contained in a .xls spreadsheet or third-party software like Carta.com, which tracks all of your company’s securities (i.e., stocks, options, and warrants) and owners. Your “fully diluted” cap table assumes all convertible securities will eventually convert to equity and decodes the percentage ownership in the company for each of your investors. Understanding your cap table in advance reduces the chance you’ll have more dilution than anticipated, preventing you from owning less of your company than originally planned.
5. No SAFE-ty in numbers.
Beware of issuing too many SAFEs for a single startup. A higher number increases the risk of giving away too much ownership of your company, which could potentially bar you from raising a subsequent equity financing round with a new lead investor such as a venture capital fund. Venture capitalists generally need to meet their fund’s required ownership targets to achieve a desired rate of return on investment. Prior to signing a SAFE, you should ask whether a SAFE is setting your company up for success for a future priced equity round and presents the best “strategic” option for your current stage of development, not just the fastest.
Still thinking of doing a SAFE or want to learn more about cap table management? Contact us at email@example.com to get it going.