SAFEs for Startup Financing
SAFEs (Simple Agreement for Future Equity) for Startup FinancingIn this article, we will attempt to provide a basic overview of one of the simpler methods of equity fundraising utilized by startups – the “SAFE” which is an acronym for Simple Agreement for Future Equity.
Is SAFE Financing Really Safe? What You Should Know as a Startup Founder or an InvestorIn the past, startups were typically funded by equity offerings or by loans secured by convertible notes. But recently, it has become common for many startups to offer their investors a hybrid type of security called a SAFE which stands for Simple Agreement for Future Equity. A SAFE is an agreement between an investor and the company where the investor agrees to give the company an upfront investment. In exchange, the investor gets a future equity stake upon an agreed-upon future trigger event. Similar to a convertible note, a SAFE allows a company to raise capital while affording an investor a future stake in the company.
The Background of SAFE FinancingDeveloped in late 2013, SAFE fundraising was originally introduced by startup accelerator Y Combinator as a more convenient alternative to convertible notes for startup owners. SAFE financing allows a company to raise funds, but without a formal valuation of the company. The investor buys a future stake in the company’s equity, but, unlike a convertible note, it is not considered debt. In fact, there is no interest rate or even maturity date. Instead, the SAFE converts to equity shares upon a set “triggering” event. It may be helpful to understand the original purpose of SAFEs. SAFEs were designed primarily with silicon valley startups in mind. A SAFE enabled venture capitalists to invest in a startup more quickly and efficiently, with the focus on seizing an opportunity, not necessarily the safety of the investment. The simple mechanisms of SAFEs were designed for these fast-growing startups to attract quick capital from investors without the formalities. While the first SAFES were designed for startups to raise small amounts of capital quickly, they are now being used more frequently to raise larger amounts of capital. Although they are becoming more commonplace, it’s important to understand SAFE financing from both a founder’s and an investor’s standpoint.
How SAFEs WorkStartups use SAFEs to raise capital by offering investors future equity shares at a pre-agreed trigger event in exchange for upfront capital. The investor is commonly offered a discount to the market value of shares when the SAFE does convert. There are typically two types of events that will trigger a conversion: a qualifying round when the company issues shares to raise additional equity investment, or an exit event when a company lists on an exchange or when it sells its shares or assets. When a founder is using SAFE financing to raise capital, it is important to fully understand the variables, including
- What events will trigger the conversion
- What terms to consider when negotiating a SAFE
- What steps must be taken to trigger the conversion
- How shares that are issued to investors will be calculated
- How the conversion will effect dilution