SAFE: What is it, types, clauses and differences with the Convertible Note?

What is a SAFE?

The SAFE (“Simple Agreement for Future Equity”) is a document that was generated by YCombinator, so that startups can raise capital quickly and easily. Its mission is to enable startups to receive money (investment) and in return to give, in the future, shares in the company.

What types of SAFE are there?

Generally speaking, there are 2 types of SAFE:

1. SAFE Pre-Money:

• In a pre-money SAFE, the valuation of the company is established before including the capital raised through the SAFEs. This means that the amount invested through the SAFEs is added to the pre-money valuation to determine the post-money valuation.
• The impact of this structure is that SAFE investors have a clearer idea of the percentage stake they will get in the company, as the valuation is already fixed prior to their investment.
• However, this may be less favourable for founders, especially if a significant amount is raised through SAFEs, as the dilution of their stake is calculated before any additional equity investment.

2.- SAFE Post-Money:

• In a post-money SAFE, the valuation of the company is calculated after including the capital raised through the SAFEs. That is, the post-money valuation includes both existing capital and new capital from the SAFEs.
• This provides a clearer picture of dilution for the founders, as they can more easily calculate their ownership percentage after all SAFE investments.
• However, for investors, this can mean greater uncertainty regarding their final percentage stake, especially if the startup raises a significant amount of money through multiple SAFEs.

In addition, each of them may have variations depending on the following clauses:

• Discount
• Valuation cap
• Most Favoured Nation (MFN)

What kind of clauses does a SAFE usually contain?

• Amount and timing of investment. This clause indicates the amount of investment and the time of investment. The time standard is immediately after the document is signed. Beware of signing a SAFE with an investor who does not have the capital to cover the commitment.
• Valuation cap, i.e. what the price per share will be capped at. In other words, what is the maximum valuation amount at which the investor will convert the shares in the future.
• Discount. That is, what share price discount can be given to the investor as a benefit for investing at an early stage. The standard percentage is normally 20%.
• Conversion event. Provisions defining the times at which the investor may convert his investment into shares.
• Investor rights. Rights to which the investor will have access as part of the investment.

What benefits does a shareholder usually have in a SAFE?  Or, in other words, why would an investor prefer to invest in you through a SAFE rather than in direct shares?

• The investor receives a preferential price over investors in future rounds which is tied to the CAP or discount (whichever is more favourable to the investor).
• Benefit on dividends.
• Preferential benefit in case of liquidation.

What types of conversion events or triggers are likely to occur? Or, in other words, at what point will the investor hold shares in the company?

Also known as conversion events, these are the triggers that result in the SAFE converting the investor into a shareholder of the company as a result of their past investment. The most common conversion events are the following:

• Equity Round – Series A. Also known as the “Priced Round”, this is when the company raises an investment round with a real valuation where there is an exchange of shares for cash. This round is a standard Series A round.
• Purchase of the company. I.e. in case of an “Exit”.
• IPO. Initial Public Offering or also known as IPO.
• Liquidation of the company. That is, liquidating the company’s assets for closure.

The same type of conversion events, or Triggers, can also be captured in the SAFE as Liquidity events.

SAFE vs Convertible Note Comparison: Is a SAFE and a Convertible Note the same? Which instrument to use, SAFE or Convertible Note?

1.- Definition and Structure:

• SAFE: A SAFE is an agreement that gives an investor the right to convert their investment into shares of the company at a future date, usually in the next round of financing. It is not a debt and does not have a maturity date or interest.
• Convertible Note: A short-term debt instrument that converts into equity, usually also in the next round of financing. Unlike the SAFE, it accrues interest and has a maturity date.

2.- Interests:

• SAFE: Does not accrue interest.
• Convertible Note: It does accrue interest, which is added to the principal and converted into shares upon conversion.

3.- Expiration Date:

• SAFE: No maturity date. This means that there is no redemption obligation if no conversion events occur.
• Convertible Note: Has a maturity date, on which the company must repay the principal and interest if it has not been converted into shares.

4. Conversion into Shares:

• SAFE: Conversion into equity generally occurs when the company receives a significant investment in a future round or liquidity event.
• Convertible Note: Converts into equity usually at the next round of financing or at maturity, often at a discounted price compared to new investors.

5.- Legal Complexity and Costs:

• SAFE: Typically simpler and with lower legal costs, as it is not a debt and does not require managing interest or maturity dates.
• Convertible Note: Can be more complex and costly due to the need to manage interest, maturity and conversion terms.

6.- Risk and Preferences:

• SAFE: Generally considered less risky for founders, as there is no repayment obligation.
• Convertible Note: May be perceived as more risky for the company due to the repayment obligation if not converted.

If you liked this article, you may also find it interesting to read the following one:

Legal Defence for Business Angels: Protecting your Investments.