A Easy Settlement for Future Fairness (SAFE) is a contractual settlement between a startup firm and its traders. It exchanges the investor’s funding for the appropriate to most well-liked 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. Not like a convertible be aware, 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 traders to lift capital rapidly and easily. Since then, virtually all Y Combinator startups have used SAFE in early-stage fundraising. Exterior of the Y Combinator group, the SAFE has develop into extremely well-liked 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:
- SAFE: Valuation cap, no low cost
- SAFE: Low cost, no valuation cap
- SAFE: Valuation cap and low cost
- 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 clarification). Nevertheless, it stays a preferred model of SAFE. The SAFEs are simple to make use of off the shelf with minimal modification. Nevertheless, traders and founders typically amend phrases in SAFEs with the steering of counsel to create their very own variations.
Key Phrases for SAFE Funding
Excessive Decision Fundraising: Advantages of SAFE Agreements for Startups
SAFE has been welcomed by the startup group 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 easy with fewer variables to know 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 now not have to fret about holding monitor of curiosity or asking traders for extensions when maturity dates method. This permits 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 detrimental because the traders may very well be left with nothing, {most professional} seed stage traders perceive the dangers of investing in early-stage startups. Nevertheless, SAFE is just not appropriate for traders who count on compensation of an funding ought to it fail.
● Excessive-resolution fundraising—A typical spherical of funding requires a whole lot of coordination to get traders 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 typically not so easy or protected.
● No fairness stakes—Being a SAFE investor doesn’t entitle one to the rights of a stockholder. SAFEs are usually not fairness stakes within the firm, so SAFE traders are usually not protected beneath state company legislation or federal securities legislation. As an alternative, SAFE traders are entitled to a future fairness stage provided that sure triggering occasions happen. If the triggering occasion by no means happens, a SAFE investor may be left with nothing.
● Too simple—Sarcastically, the primary characteristic of the SAFE—its simplicity—can be a bug. As a result of it’s develop 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, and so they understand how a lot of their firm they’ve given away and the way a lot it has diluted them.
SAFEs Convert Into Most popular Inventory in Fairness Financing
The SAFE converts into fairness on the subsequent spherical of funding the place the corporate sells most well-liked inventory at a set valuation. Not like certified financing within the convertible be aware, there isn’t any minimal measurement of the spherical.
Upon an fairness financing, the capital that the SAFE investor invested converts into shares of most well-liked inventory within the firm. The shares can have the very same preferences, rights and restrictions as the popular shares of the brand new traders within the fairness financing (new traders). Founders ought to do not forget that when they’re negotiating the phrases with the traders in an fairness financing, they’re negotiating for the shares of the brand new traders in addition to the SAFE traders. The variety of most well-liked shares that the SAFE will convert into is dependent upon 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 handle the upper danger of funding that SAFE traders take when investing in an early-stage startup. It’s a low cost off the worth per share paid by new traders within the fairness financing. The low cost could vary anyplace between 5% to 30%, with 20% being the norm.
For instance, if the SAFE traders get pleasure from a 20% low cost and the traders within the subsequent spherical of financing (new traders) buy most well-liked shares at $1 per share, the SAFE traders would solely pay $0.80 per share. The upper the low cost charge, the extra fairness SAFE traders would obtain for his or her funding.
The low cost charge is clearly said 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%.
Generally the low cost alone will not be adequate in defending an early investor’s curiosity. Thus, some traders 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 sometimes 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 best valuation at which the quantity invested within the SAFE can 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 traders are investing within the firm at a $20 million valuation, then SAFE traders will likely be paying half worth for his or her shares relative to the brand new traders. (They will purchase twice as many shares for his or her cash as the brand new traders.)
Founders ought to at all times preserve future rounds in thoughts once they set a cap on their SAFE. The SAFE traders are taking a danger 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 most likely don’t need them to be shopping for at half worth of the brand new traders. If the cap is just too low, founders danger giving up an excessive amount of fairness to the SAFE traders and diluting themself within the course of.
What’s Higher for Founders: Low cost or Cap?
Usually, the perfect state of affairs for founders is for the SAFE to be uncapped and discounted. This rewards the convertible be aware investor for taking over early danger. It additionally avoids the problem of assigning an arbitrary worth to the corporate, which may very well be too excessive or too low.
Some traders insist they’ll “by no means” put money into a SAFE and not using a valuation cap. Nevertheless, the result is dependent upon the bargaining energy of the events concerned. On the pre-seed stage, an uncapped SAFE may recommend the corporate is engaging and has some leverage in negotiations, which may assist attract higher traders for later rounds of fairness financing.
Nevertheless, not all early-stage startups have traders eagerly ready to take a position. When negotiating a valuation cap, founders ought to be sure that it’s set at an inexpensive stage—ideally greater than what the corporate may 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 workforce. Take a look at this video to be taught extra. For a deeper dive, learn this information.