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What is a SAFE Note?
A SAFE Note is a contract by which an investor makes a cash investment into a company in return for the rights to subscribe for new shares in the future.
Under a SAFE (Simple Agreement for Future Equity), the investment is converted into equity when there is an “equity financing”, a “liquidity event”, or “a dissolution event”.
Contrary to a Convertible Note, a SAFE does not carry interest, does not expire, and does not specify a minimum amount of funds to be raised at the equity financing.
Why are SAFE notes not safe for entrepreneurs?
A SAFE is similar to a convertible note because both entitle the investor to receive shares in the future at a preferential price. However, these two instruments are fundamentally different because a convertible note is a debt but a SAFE is not. There might be chances a SAFE will never convert into equity and investors won’t get back their money.
What are the differences between a SAFE and a Convertible Note?
A SAFE is a contract between an investor and a company, through which an investor invests into a company in return for future equity shares with no specific deadlines. Whereas a Convertible Note is a debt instrument that converts into equity under predefined conditions, typically in qualified financing, at a liquidity event, or on the maturity date. These are the main differences between a SAFE and convertible note.
- Convertible Note has a maturity date upon which, if the conversion doesn’t take place, the company will return the investment amount to the investor, but a SAFE does not.
- Convertible Note carries interest, but a SAFE does not.
- Convertible Note identifies the minimum amount of funds to be raised at the equity financing, but a SAFE does not.
What are the advantages of raising capital through SAFE Note?
A business can raise capital through different means however raising it through a SAFE has several benefits like:
Easy to negotiate: Raising capital through a SAFE is quick and easy to negotiate because there are very few legal formalities involved. Businesses don’t have to worry about valuation cap or other debt elements, a simple self-explanatory SAFE document is enough to raise the capital.
Not interest-bearing: A SAFE is not interest-bearing so there is no extra work needed to convert the interest into equity.
No fixed term: Unlike other capital raising instruments, a SAFE doesn’t have any fixed term so there is no need to worry about the deadlines. If the company never reaches the trigger event, no shares are issued.
Uncapped safe notes:
SAFE notes can be capped as well as uncapped. “Cap” here means a ceiling on the valuation when the notes mature. With a capped investment round investors are able to put a ceiling on the valuation for when the notes will convert into equity. It gives investors a picture of how much of the company they will own. A capped valuation is the value of the investment that the investors get. On the other hand, uncapped safe notes have no cap applicable and so are mostly favored by founders and entrepreneurs. It is less preferred by investors as it does not give a guarantee of value for the investment made.
However, that does not discourage investors from using uncapped Safe notes. When used at the right time, it can help investors get fair compensation with a discount. Uncapped SAFEs can be used to balance the needs of both a founder and an investor. It can be a good choice for both if the investment is dropping off right before an equity round, where the investor will be pitching in the investment before a round of fundraising.
In early investing, the valuation caps help limit investing risks. However, calculated investments made with uncapped SAFE notes can profit both investors as well as founders. For founders, uncapped notes can be the financial tool that helps them, build, grow and increase the value of a company more freely.
A SAFE is designed to be simple and short. It saves you the trouble of negotiating and agreeing on the amount of equity financing, which is often quite difficult to agree upon between the investor and the company at an early stage of the business.
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Along with this document, make sure you see these other templates in our library:
- SaaS Agreement
- Freelance Agreement
- Simple Agreement for Future Equity
- Fast Agreement
- Share Option Plan
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