SAFE: What It Is, and Why It's Better for Founders and Investors

A SAFE stands for Simple Agreement for Future Equity. Bottom line up front: a SAFE is an alternative to the traditional convertible note structure. It has the advantages of convertible debt without some of the disadvantages, with the intent of streamlining the funding process for both startups and investors while keeping the cost of scoping and executing the transaction to a minimum. This instrument is typically used in early-stage financing and is not intended for larger, later rounds that might warrant additional complex terms.

SAFEs were created by Y Combinator, the top accelerator in the world, and have been used by thousands of startups. This global legitimacy allows investors to sign on quickly, helping the startup raise money faster and get back to building their product and increasing the value of those shares, something both investors and founders ultimately want, compared to spending money on deeper legal fees or time negotiating terms on a convertible note.

Convertible Debt and Its Drawbacks

The key reason many players in the high-growth startup space use convertible debt is that it makes fundraising quicker. Typically you don’t have to negotiate many of the intricate details you would if you were selling the actual security of a stock to an investor. The convertible portion of the instrument allows the investor to buy the stock when there is a full equity round.

The drawback of using convertible debt is that both tax and legal complications inherently increase the cost of the convertible note vehicle. A debt instrument requires a length of time it is in place for, and there has to be an interest rate, which in many states has to be near market rate. This interest piece makes converting the note uniquely complicated, and the requirement for a term length also increases complexity if the note has to be extended.

A Simpler Way

The key for a SAFE is that it can have a valuation cap or be uncapped, just like a convertible note. The important takeaway is that the investor does not buy the stock itself, but the right to buy stock in an equity round when it occurs. There is also typically a discount on that stock, in most cases, an option to buy at 80% of the price.

A SAFE generally includes five sections: events (what happens if something happens in your company, equity financing, a liquidity event such as a sale or merger, dissolution, liquidation priority, and termination); definitions; company representations; investor representations; and various legal boilerplate.

SAFEs are now largely “post-money,” meaning founders know exactly how much dilution they’re getting, because they know the capped valuation of the company inclusive of the value of the money being put in. The simple formula is: pre-money valuation + money raised = post-money valuation. For example, with a pre-money valuation of $3M and a raise of $500k, your post-money valuation is $3.5M. You can determine how much you’ve sold by dividing the money raised by the post-money valuation cap, in this case, $500k divided by $3.5M equals 14.3% of the company sold in that SAFE round.

The Different SAFE Variations

• Discount: The investor gets a straight discount in the coming round. A 20% discount means they get shares in the next round for 80% of the price, they only pay 80 cents for $1 worth of shares.
• Uncapped: The investor is willing not to put a cap on the valuation, but rather rides along with the valuation of the priced equity round. This is uncommon, because many investors like some benefit for putting money in before others.
• Uncapped with a “most favored nation” clause: Uncapped until another investor comes along with more favorable terms, at which point the investor rides along on those better terms.

Keep in mind that each time you go back to the venture trough as a founder, you typically sell between 10% and 30% of your company, roughly 15% at SAFE/seed, 20% at Series A, 25% at Series B, and so on. It’s incredibly important to understand how much dilution you’ll have. At the end of the day, the important thing to remember (as an investor, a founder, or an early employee) is that while dilution happens (you own a lesser percentage of the company), ideally the share value increases each time you raise. You own a lower percentage of shares, but the overall value of those shares is much higher than before you took on the new money.

Got any questions or comments? You can reach me at patrick@render.capital.