What is a SAFE?

A SAFE (simple agreement for future equity) was created by Carolynn Levy, a lawyer for Y Combinator, who then open sourced it.  Essentially, it’s purpose is to be a simple alternative to convertible notes. SAFEs accomplish the main goals of a convertible note, however a SAFE differs in that it is not a debt instrument.

The investor, by investing in a startup via a SAFE, buys the right to receive shares in a future equity raise.

 

Why do startups raise investment capital using SAFEs?

Convertible notes can be cumbersome for both startups and investors. For example, if a maturity date comes up and the startup is not ready to raise more capital, it can put investors and startups in conflict, which does not serve either party. If the startup wishes to extend the maturity date, they will need to request it, and investors will have to work through extension papers as well. SAFEs make this all simple, by removing the maturity date altogether. Negotiation time and legal cost is also reduced due to the simplicity of the document.

 

What are the key parameters in a SAFE?

A SAFE document may consist of three key points, which work similarly to their counterpoint used in convertible notes:

Is there a valuation cap or not? if yes, what is the valuation cap?

Is there a discount or not? if yes, what is the discount?

Is there a most favored nations clause or not?

 

How does a SAFE compare to a convertible note?

SAFEs are a convertible security, however convertible notes are debt. Convertible notes then include both an interest rate and maturity date, which a SAFE does not.

SAFEs tend to be shorter and simpler, about 5 pages long.

Both SAFEs and convertible notes can convert into equity in a future round, although convertible notes tend to be more complex with regards to when, if, and how they convert.

 

Numerical Example: SAFE, cap, no discount

Investor has purchased a safe for $100,000. The Valuation Cap is $5,000,000.

The company negotiates with investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000 shares.

The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue and sell 220,022 shares of Series A-1 Preferred to the safe holder, at $0.4545 per share.

In the safe, the Series A Preferred is referred to as “Standard Preferred Stock” and the Series A-1 Preferred is referred to as “Safe Preferred Stock.” The analysis below sets forth a comparison between the Standard Preferred and the Safe Preferred, as each would be described in the company’s certificate of incorporation:

Liquidation preference on a per share basis: - Standard Preferred Stock: $0.90 - SAFE Preferred Stock: $0.4545

Aggregate payout in a change of control transaction (each series pari passu with the other): - Standard Preferred Stock: $1,000,000 - SAFE Preferred Stock: $100,000

Conversion price and original issuance price at the time of the Series A Preferred financing: - Standard Preferred stock: $0.90 (initially converts into 1,100,110 shares of common stock) - SAFE Preferred Stock: $0.4545 (initially converts into 220,022 shares of common stock)

Dividend Rate per share (based on an 8% dividend): - Standard Preferred stock: $0.072 - SAFE Preferred Stock: $0.036

 

Numerical Example: SAFE, discount, no cap

Investor has purchased a safe for $20,000. The Discount Rate is 80%.

The company has negotiated with investors to sell $400,000 worth of Series AA Preferred Stock at a $2,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing is 10,500,000 shares.

The company will issue and sell 2,105,263 shares of Series AA Preferred at $0.19 per share to the new investors. The 20% discount applied to the per share price of the Series AA Preferred is $0.152. Accordingly, the company will issue 131,578 shares of Series AA-1 Preferred to the safe holder, at $0.152 per share.

 

Numerical Example: SAFE, cap and discount

Investor has purchased a safe for $100,000. The Valuation Cap is $8,000,000 and the Discount Rate is 85%.

The company has negotiated with investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000 shares.

The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue Series A-1 Preferred to the safe holder, based on the Valuation Cap or the Discount Rate, whichever results in a lower price per share. The 15% discount applied to the per share price of the Series A Preferred is $0.77265. The Valuation Cap results in a price per share of $0.72727. Accordingly, the company will issue 137,500 shares of Series A-1 Preferred to the safe holder, at $0.72727 per share. The Discount Rate does not apply in this case.

 

Sources:

FundersClub: https://fundersclub.com/learn/safe-primer/safe-primer/safe/

Y-Combinator: https://blog.ycombinator.com/announcing-the-safe-a-replacement-for-convertible-notes