Like every typical startup company at the beginning of its road, you’re probably looking to raise funds and not really sure what is the best and most efficient way to do it. This article will provide a short explanation about one type of instrument called SAFE (Simple Agreement for Future Equity), used to raise funds, especially in early-stage companies.
A SAFE is an agreement between the company and an investor, which enables the company to raise funds from the investor, while in return giving the investor the right to acquire equity in the company at a future date, namely once the company closes an equity financing round (and the parties may also agree regarding the required minimum size of such financing for the purpose of conversion of the SAFE investment), or upon an M&A transaction or an IPO (whichever is earlier). Once any such event occurs, the investor’s investment is converted into the company’s equity at certain predetermined conditions, typically at a discounted price per share (compared to new investors/acquirers), or at a company valuation which is capped (i.e., the price per share the SAFE investor will get cannot exceed a certain threshold even if the actual valuation of the company at the time reflects a higher price per share).
The idea is to provide a simple and short instrument allowing young companies to raise money quickly, without the need to predetermine the company’s valuation, which is often the biggest gap between an early-stage company and potential investors when negotiating an investment.
Basically, a SAFE is somewhat similar to a Convertible Loan Agreement, however, the key difference is that the funds invested under a SAFE are not intended to be repaid to the investor, except in case of a default event such as the company’s shut-down/liquidation or insolvency.
The main advantage of the SAFE is, as aforesaid, in its simplicity and the lack of need to predetermine the company’s valuation, which enables a quick and relatively easy, and presumably more cost-effective fundraising (fewer negotiations = less legal fees). Additionally, since investments under SAFEs also typically don’t accumulate interest, such investments will most likely be exempt from various laws designed to apply tax on interest, which again helps to reduce hassle while negotiating and drafting a SAFE (however, you should note that if a certain discount is provided with respect to the price per share at the conversion date then the tax authorities may claim that such discount should be deemed as interest).
However, that being said, as SAFEs became more popular recently, it also became apparent that a SAFE may not be so short and easy after all. It is still a legal document which contains fairly complex legally drafted clauses, and taking into account the discount and/or cap issues, at least one of which is almost always included in a SAFE, the company may end up spending the same amount of time, effort and money negotiating a SAFE as any other similar agreement such as a Convertible Loan Agreement.
Additionally, taking into account said differences between a SAFE and a Convertible Loan Agreement, some sophisticated investors may object to using a SAFE and prefer an instrument allowing them more control over their investment (e.g., a repayment option, interest, etc.).
Right here at the JumpStart website you can find a variety of customizable agreements for download, including a SAFE.