Understanding SAFE: Simple Agreement for Future Equity
What is a Simple Agreement for Future Equity (SAFE)?
The simple agreement for future equity (SAFE) was first introduced by Y Combinator in late 2013 and has become a common convertible instrument used by start-up and early-stage companies to raise capital. A SAFE is a contract between a company and an investor that allows the investor to convert their investment into equity of the company upon certain triggering events, like a future equity financing. SAFEs can be a simple tool for start-ups, but it’s important for companies to understand what they are using and what the implications may be.
Post-Money vs. Pre-Money
Generally, when calculating the number of shares a SAFE investor will receive upon conversion, a post-money SAFE will include the SAFEs converting into the priced round in the capitalization calculation. Investors typically prefer post-money SAFEs since they can determine the percentage of the company they will own immediately before the priced round. While it may be nice for the investor to know what their investment represents, the dilution resulting from issuing additional SAFEs will be borne by the existing shareholders. Conversely, a pre-money SAFE will not include the SAFE (nor other SAFEs converting into the priced round) in the conversion calculation. So, the subsequent SAFEs issued by the company will dilute the percentage ownership of the other SAFE investors.
Commonly Customized Terms
Notwithstanding the purchase price of the SAFE, the following are commonly customized terms:
Valuation Cap. The Valuation Cap is the highest valuation at which the amount invested in the SAFE can be converted into shares of the company, regardless of the company’s valuation at the triggering event. So, this can lead to the SAFE investor receiving a higher number of shares as they are paying less per share compared to the other equity investors in the priced round which may be purchasing shares based on a higher valuation.
Discount. Compared to the equity investors in the priced round, a discount will provide the SAFE investor with a direct discount on the share price of the shares issued upon conversion in the priced round. SAFEs typically refer to a discount rate, which is the amount payable once the discount is applied. So, a discount of 20% will be reflected as a discount rate of 80%.
Most Favored Nation (MFN). If a subsequent convertible security issued by the company has more favourable term(s), an MFN provision allows the SAFE investor to choose to amend their SAFE to also receive the same favourable term(s).
If you have any questions about utilizing SAFEs in your business, feel free to contact us at info@lwlaw.com.
Note: The foregoing is intended to provide general information and does not constitute legal advice. You are encouraged to seek legal advice specific to your circumstances.
