And no, a SAFE has nothing to do with safety or security. It is an acronym for ‘Simple Agreement for Future Equity.’ The original concept of a SAFE was created by Y Combinator and it is open-sourced.
A SAFE is an investment contract between investors and a company that is raising capital. Individuals make investments in exchange for the chance to earn a return in the form of equity in the company, if the company experiences another round of financing, is acquired, or has an IPO. SAFEs are neither equity nor debt – they represent a contractual right to future equity, in exchange for which the holder of the SAFE contributes capital to the company now.
In practice, a SAFE enables a startup company and an investor to accomplish the same general goal as a convertible note, though a SAFE is not a debt instrument. Like convertible notes, SAFEs enable investors to convert their investment into equity during a future round of financing (sale of stock) and can include discounts or valuation caps. However, unlike convertible notes, SAFEs do not have a maturity date – so a SAFE might never convert to equity, and there is no requirement that the company repays investors. In addition, SAFEs do not accrue interest. Though investors in SAFEs are not entitled to stockholder rights, in the event of a liquidation they are paid before the liquidated assets of the company are distributed to stockholders, but after creditors of the company.
How SAFEs Work
Investors who invest in companies using a SAFE get a financial stake in the company but are not immediately holders of stock. Investments are converted to equity if certain “trigger events” occur, such as the company’s future financing, acquisition, IPO, or another event pre-determined by the SAFE. It is important to note that trigger events are not guaranteed. Investors and companies should think of trigger events as possibilities and not certainties.
Typically, companies customize SAFEs, including or excluding certain provisions. Most SAFEs include a valuation cap and a discount, others simply specify the price at which shares can be acquired in the future.
The below are examples of terms that may be found in a SAFE:
A valuation cap specifies the maximum valuation at which a SAFE holder’s investment converts into the stock of the company or, in some instances, cash. When a trigger event occurs – another round of financing, a sale of the company, an IPO – the SAFE holder receives equity shares or cash at the valuation cap price, no matter the valuation at which the company sells. Therefore, the higher the valuation of the company at the time of sale, the greater the SAFE holder’s return.
If a trigger event for the company occurs, the discount provision gives investors equity shares (or equal value in cash) at a reduced price relative to what others pay for the shares.
Price per share.
The price per share denotes the cost per share at the time the SAFE converts into equity shares or cash. This means that investors, when a trigger event occurs, receive equity shares or cash as if they had purchased shares at the time of the SAFE purchase.
So why use a SAFE? A SAFE enables early-stage companies to easily raise money from friends, family, and angel investors without the complications associated with priced equity rounds, such as establishing a value for the company, or with debt instruments, that have accounting and tax consequences. In many ways, it is a matter of preference.