An investment contract devised to allow start-ups to raise quick capital without the burden of a traditional equity offering
In the last few years, start-up companies raising capital have often resorted to proposing Simple Agreements for Future Equity (SAFEs) to early stage investors.
A SAFE grants the investor the right to receive equity of the company upon the occurrence of certain pre-established corporate events, such as a future equity financing, the sale of the company, the merger of the company with another company, or an initial public offering. SAFEs are not common stock or debt instruments, but are considered securities. This means that companies using SAFEs to raise capital are required to approach the investor in compliance with US securities law.
The most significant and heavily negotiated provisions of SAFEs are the conversion terms, which establish the amount of equity the investor will receive if the triggering event is generated. Specifically, conversion terms are structured as incentives for investors: a valuation cap imposes a limit on the stock conversion price; in other words, the early stage investors will receive equity priced at the lower of the valuation cap established in the SAFE or the valuation of the subsequent financing; a discount rate ensures that SAFE investors will pay a lower price (typically between 10% and 30%) than subsequent investors for the same amount of equity received.
SAFEs have become increasingly popular because they can be easily closed individually with each investor without the need to coordinate simultaneously with other investors. Additionally, SAFEs maintain the advantages given by convertible notes in connection with the conversion to equity (capped value and discount price), without accruing interests or having a maturity date. On the other hand, however, SAFEs do not afford certain protections given to convertible note holders, such as the possibility to have the investment repaid and secured against the assets of the company. The investor should understand that the triggering event might not occur. The company might still be operating and even raising funds through means not contemplated in the triggering events – for instance, by issuing common stock or by taking out a conventional bank loan. In all these cases, the early stage SAFE investor would remain empty handed.
Although only the conversion terms are typically negotiated, a savvy SAFE investor might also want to secure some limited voting rights and liquidation rights in the event of dissolution.