A Simple Agreement for Future Equity, commonly known as a SAFE, is a security often used by early-stage companies to raise capital. A SAFE is intended to simplify and improve upon the convertible note structure that has been popular for start-up companies since the 2000s. This article discusses the general elements of a SAFE and compares them to convertible notes.
Convertible Notes
A typical convertible note for an early-stage company accrues interest and converts it into common stock or preferred stock upon the occurrence of future financing, acquisition, and/or a public company event. This future conversion structure allows founders and investors to delay determining the company’s valuation. The conversion is generally at a discount to the offering price and has a valuation cap, which rewards investors for taking on early investment risk. As creditors, if there is a dissolution, repayment to note investors has preference over all equity holders. In addition, convertible notes have maturity dates, which limit investor exposure in the event future financing does not occur within a specified period of time.
SAFEs
Similar to convertible notes, SAFEs create an option to buy equity in the future by converting it into a subsequent financing round. SAFEs generally include a valuation cap and/or conversion discount. SAFEs, however, are not debt instruments, as they do not accrue interest or have a maturity date. In addition, unlike typical convertible notes, SAFEs generally do not specify a minimum financing amount required to trigger conversion. If the company dissolves, SAFE holders have distribution rights senior to holders of common stock, but not to holders of preferred stock or debt holders.
In a typical SAFE, if there is an acquisition or a public company event, the holders have an option to either (i) receive a cash payment equal to the purchase price they paid for the SAFE, or (ii) receive a number of shares of common stock equal to the purchase price paid for the SAFE, based on the specified valuation cap. This gives investors the flexibility to take their money off the table upon an acquisition or public company event, however, if they elect to do so, they receive no reward for making the investment in an early-stage company.
Some SAFEs include a provision permitting the company to repurchase the SAFE prior to an acquisition, for the greater of (i) the purchase price paid for the SAFE, and (ii) the fair market value of the SAFE as determined by an independent appraiser. While this may be deemed unfair to investors, there is often a safeguard that provides that if an equity financing occurs within a specified period of time after the repurchase (i.e., 3 months), and the repurchase price is less than the value of the shares the SAFE holders would have received had the repurchase not occurred, the company shall pay the investor an amount equal to the difference in value.
SAFEs are a founder-friendly instrument, offering substantial benefits to founders over convertible notes, primarily because SAFEs do not have a looming maturity date and do not accrue interest. They can also provide the founders with a method of buying out the investors. SAFEs are also simpler instruments and easier to administer than convertible notes.
The information contained in this article is strictly for educational purposes and is not intended to be legal or tax advice or to be relied upon by anyone without doing their own research, and consulting with legal and tax advisors.