SAFEs

What is a SAFE?

SAFE stands for Simple Agreement for Future Equity. The SAFE was developed in California and popularized by leading Silicon Valley accelerator, Y Combinator. SAFEs are intended to streamline the seed financing process as an alternative to convertible notes. Transaction efficiency is good for companies and investors, and SAFEs have been used on many seed financings. SAFEs also defer, to a certain extent, the difficult question of company valuation.
Business terms in a SAFE are kept to a simple list of items:

• Valuation Cap: The valuation cap is the most common business term included in a SAFE. The valuation cap is the upper limit on the company’s pre-money valuation when calculating the SAFE conversion price. Think of this as upside protection for SAFE investors. If the pre-money valuation on an equity financing round is higher than the valuation cap, the investor receives a number of shares based on the valuation cap, not the higher valuation set for that equity financing round. If the pre-money valuation is lower than the cap, the conversion price will be the price set by the equity financing.
• Discount: A discount can be used for further investor incentive. This is a discount to the price per share issued on the equity financing round. If there is a discount AND a valuation cap, the conversion will usually be based on the lower conversion price (i.e., more investor favorable). A lower conversion price is better for an investor because it increases the total number of shares received on conversion.
• MFN Clause: In a most favored nation (MFN) clause, if subsequent convertible securities are issued to future investors at better terms (e.g., a lower valuation cap), the better terms will automatically apply to the investor’s SAFE. This clause falls away on conversion of the SAFE into company stock.

When will a SAFE conversion be triggered?

Most SAFEs contain a typical set of triggers for conversion into company stock. Usually, conversion is triggered when a company completes a round of equity financing. Often there is a minimum size for the round, for example, the company must raise more than US$1,000,000 for SAFEs to convert. Other typical triggers include the acquisition of the company, initial public offering (IPO), or the winding-up of the company.

What are the benefits of SAFEs?

As they were originally conceived, SAFEs are quite company-friendly and seem to foster patient capital investments. Standard SAFEs do not carry interest and do not have a maturity or repayment date where companies are on the hook to pay their investors back. SAFEs do not expire the way convertible notes do, but terminate on certain events like conversion into preferred stock on an equity financing round. Once the investment is converted into company stock, the SAFE investors will typically be granted a pro rata right to maintain their equity percentage by participating in follow-on equity or convertible debt financing rounds.

SAFE financing rounds can also be quite efficient from a time and professional fee standpoint. The round usually involves customizing the SAFE and obtaining board approval, and in the rare case, stockholder approval. Companies also need to comply with their local securities laws and the securities laws of the investor’s jurisdiction.

Questions? Email us at startups@dentons.com.