Startup founders have a few go-to financing tools when raising capital—among them, SAFEs (Simple Agreements for Future Equity), convertible notes, and National Venture Capital Association-style priced equity rounds. Many companies in their early stages use SAFEs at some point to raise capital because they are easy and quick. A key component of any financing is the valuation, which is often contentious. The use of a SAFE enables the company and the investor to delay this determination but still access much-needed funds. This article takes a detailed look at how SAFEs work and why they’re commonly used.
Business Transaction Attorneys have over three decades of experience in helping clients with the financing of their businesses. We can guide you through the process of using a SAFE to finance your start-up business. At a minimum, we would recommend consulting an attorney versed in this type of financing before closing on a SAFE.
What Is a SAFE?
A SAFE is a flexible investment contract created by Y Combinator in 2013. It grants investors the right to future equity, typically converting into preferred stock during the company’s next priced round. Until that happens, it isn’t considered equity—it’s an agreement that becomes equity later under specified conditions.
How and When SAFEs Convert
SAFEs generally convert during the next priced round based on either a discount to the new share price or a pre-agreed valuation cap. Some versions include a “Most Favored Nations” or “MFN” clause, allowing investors to match better terms from future notes.
If no priced round occurs, the SAFE may convert (or pay out) at a Liquidity Event—whichever offers the higher return between the initial investment and equity under the cap. In a wind-down, repayment is possible but only after creditors are paid, often leaving little for SAFE holders.
Key SAFE Structures
- Pre-Money SAFEs (2013): These do not include SAFE investments when calculating founder ownership. While this can seem beneficial at first, multiple rounds of pre-money SAFEs can unexpectedly dilute founders.
- Post-Money SAFEs (2018): Designed to fix that problem, these account for all SAFEs in the cap table, offering greater clarity around dilution and ownership.
Practical Tips for Founders
- Raising amounts near or above the post-money cap (e.g., $5M on a $5M cap) can lead to severe dilution.
- While typical SAFE rounds are under $2M, some push as high as $8M (not usually advisable).
- Founders should prep by organizing corporate documents, securing board consent, and ensuring securities compliance post-close (e.g., Form D).
Choosing the Right SAFE
The most widely used format today is the post-money SAFE with a valuation cap, as it strikes a balance between simplicity and transparency. Founders should exercise caution when adapting forms independently to ensure the use of the appropriate SAFE form (i.e., pre- or post-money) based on the proposed financing terms. Founders can download the standard templates from Y Combinator’s official site, or they can call Business Transaction Attorneys. We’ll send you the forms at no charge.
Want to learn more? Call Business Transaction Attorneys and set up a free consultation at +(1) 713-304-2396.