What is a SAFE Agreement?
A SAFE is a concise, one-page agreement between a startup and an investor. Unlike traditional convertible notes or equity rounds, it grants the investor the right to future equity in the company upon the occurrence of pre-defined events, such as a significant funding round, acquisition, or initial public offering (IPO).
Imagine it as a flexible pre-order for future shares with clear terms outlined upfront, eliminating months of negotiation and uncertainty.
📍 A great resource for in-depth reference
YC Partner Kirsty Nathoo goes more in-depth into SAFEs and how it impacts founder equity and cap tables. Check it out for a more in-depth guide on how cap tables and equity works.
Why every startup now uses SAFE?
1. Lightning Speed
Forget about protracted legal wrangling. SAFEs can be negotiated and signed in hours, freeing up valuable time and resources for focusing on building your business.
Unlike convertible notes with their interest rates and potential valuation caps, SAFEs typically lack such stipulations, offering founders greater control over their company's future structure and ownership.
3. Broader Investor Pool
Angels and smaller venture capital firms often find SAFEs attractive due to their ease of understanding, lower minimum investment requirements, and wider pool of potential investors. This opens doors to more diverse funding opportunities for startups.
What is included in a SAFE?
1. Settings Milestones
- Triggering Events: When specific things happen (funding rounds, acquisitions, etc.), your promise of future shares becomes real.
- Discount Rate: Early investors get a reward for their trust - a lower price per share when your promise comes true.
- Valuation Cap: This sets a limit on the company's value when your promise is fulfilled, protecting founders from losing too much control.
2. Protecting Your Company
- Liquidation Preference: If things go south and the company closes, this clause determines how investors and founders get paid back. It prioritizes investors, but doesn't leave founders empty-handed.
- Drag-Along and Co-Sale Rights: If someone wants to buy the company, these rights ensure investors can sell their shares alongside founders, guaranteeing everyone shares the exit.
- Confidentiality: Your startup's secrets stay secret. This clause keeps information under wraps.
- Dispute Resolution: If disagreements arise, this outlines how they'll be handled.
SAFE Agreement vs. Convertible Note
SAFEs are one-page agreements granting investors the right to future equity upon specific events (e.g., funding rounds, acquisitions). Convertible notes resemble debt instruments, with a maturity date and potential interest, that convert into equity under pre-defined conditions.
SAFEs typically lack valuation caps, potentially diluting founders more in future rounds. Convertible notes often include valuation caps, protecting founders from excessive dilution but potentially deterring certain investors.
SAFEs are generally simpler and faster to negotiate, making them ideal for quick fundraising rounds. Convertible notes can be more complex and require more negotiation, leading to potential delays.
4. Investor Pool
SAFEs attract a wider range of investors, including angels and smaller VCs, due to their ease and lower minimums. Convertible notes may be preferred by larger VCs accustomed to traditional debt structures.
Is a SAFE Agreement Debt or Equity?
A SAFE Agreement is neither debt nor equity in the traditional sense. It's a hybrid instrument that falls somewhere in between, offering investors the potential for future equity ownership in exchange for their early investment.
Here's a quick breakdown:
Why it's Not Debt:
- SAFEs don't accrue interest like debt.
- Investors are not guaranteed repayment regardless of the company's performance.
- They carry no maturity date for repayment.
Why it's Not Equity:
- Investors don't have immediate ownership in the company like with common stock.
- They don't receive voting rights or other shareholder benefits until the SAFE converts into equity.
- Their potential equity stake only materializes under specific triggering events, such as a higher-priced funding round or an acquisition.
Is a SAFE Agreement a security?
There is no straightforward answer, but it depends on various factors like the terms of the agreement, the jurisdiction etc.They represent an investment in a company with the expectation of future profits: This aligns with the traditional definition of a security.
The SEC has issued guidance suggesting that some SAFE agreements could be considered securities
Also on the flip side, Unlike traditional equity, SAFE holders don't have voting rights or other shareholder privileges until conversion.
They are not debt instruments, SAFE agreements don't accrue interest or guarantee repayment, unlike bonds or loans.
Some SAFE agreements may be structured in a way that avoids meeting the criteria for a security.
Concerns with SAFE Agreements
1. SAFEs were designed for a specific type of startup.
SAFEs were developed in Silicon Valley as a way for venture capital investors to quickly invest in a hot startup without burdening the startup with the more labored negotiations an equity offering may entail.
Oftentimes, for the venture capital investor, it was more important to get the investment opportunity, and possible future opportunities, with the startup than it was to protect the relatively small investment represented by the SAFE.
2. With SAFEs, you are not getting an equity stake in return. SAFEs are not common stock.
Common stock represents an ownership stake in a company and entitles you to certain rights under state corporate law and federal securities law. A SAFE, on the other hand, is an agreement to provide you a future equity stake based on the amount you invested if—and only if—a triggering event occurs.
SAFEs do not represent a current equity stake in the company in which you are investing. Instead, the terms of the SAFE have to be met in order for you to receive your equity stake.
How to create a SAFE agreement
YCombinator provides three versions of the post-money safe intended for use by US companies, plus an optional side letter. There is one version of the post-money safe, Valuation Cap (no discount), intended for use by companies formed in Canada, Cayman and Singapore, plus an optional side letter for each country.
These templates are free and easy to customise, so you can check it out here.View SAFE Agreement Templates
Additionally, you can use online platforms to create your SAFE documents. This may not be as personalised and customised to your needs compared to how a trained and qualified legal assistant may provide, but this is also an option.
Created by YCombinator
Y Combinator, the renowned startup accelerator, played a pivotal role increating and popularizing SAFEs. In 2013, they recognized the need for a more efficient and accessible form of early-stage financing, leading to the development of the Y Combinator SAFE. This streamlined version further emphasizes clarity and founder-friendliness, quickly becoming a standard within the ecosystem.
Y Combinator introduced the safe (simple agreement for future equity) in late 2013, and since then, it has been used by almost all YC startups and countless non-YC startups as the main instrument for early-stage fundraising. - YCombinator
The Future for Early-Stage Funding
The emergence of SAFEs has undeniably transformed early-stage fundraising. By prioritizing simplicity, speed, and founder-friendliness, this one-page marvel has democratized access to capital, empowered countless startups, and fostered a more vibrant entrepreneurial landscape.
Whether you're a seasoned entrepreneur navigating subsequent rounds or a budding dreamer seeking your first investment, understanding the power of the SAFE is key. It offers a smoother, simpler, and more accessible path to achieving your startup aspirations. Just remember, careful consideration and professional guidance are crucial ingredients for success.
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