Simple Agreement for Future Equity (SAFE) Agreement

How to generate a Simple Agreement for Future Equity (SAFE) Agreement

What is SAFE Agreement?

A Simple Agreement for Future Equity (SAFE) 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 Simple Agreement for Future Equity (SAFE), 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 Simple Agreement for Future Equity (SAFE) does not carry interest, does not expire, and does not specify a minimum amount of funds to be raised at the equity financing.

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 in 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 occur, 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 funds to be raised at the equity financing, but a SAFE does not.

What are the advantages of raising capital through Simple Agreement for Future Equity (SAFE)?

A business can raise capital through different means; however raising it through a SAFE has several benefits:

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 caps 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 no extra work is 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.

Tips for creating a simple agreement for future equity template

A SAFE is an instrument under which an investor makes a cash investment (the “purchase amount”) into a company in return for the rights to subscribe for new shares in the company in future upon the occurrence of specific events.

There are three possible scenarios:

(a) If the company achieves “equity financing”, the investor will receive preference shares with the same rights and preferences as the preference shares to be issued by the company at the equity financing (in which case the conversion price will be the “Safe price”. See below);

(b) If the company is sold or gets listed (a “liquidity event”), the investor is free to choose between (i) receiving cash back for the purchase amount; or (ii) receiving ordinary shares of the company (in which case the conversion price will be the “liquidity price”, see below);

(c) If the company is dissolved (a “dissolution event”), the investor will receive cash back for the purchase amount. You should note that if the company’s assets are not enough to pay back investors of all the SAFEs issued by the company before such time, the available assets of the company will be distributed with equal priority and pro rata among all investors of SAFEs.

A SAFE never expires. If none of the above occurs, the SAFE will remain, and the investor cannot get his money back unless otherwise agreed between the company and the investor.

Similar to a Convertible Note, both entitle the investor to receive shares in future at a preferential price. However, the two instruments are fundamentally different because the Convertible Note is a debt, but a SAFE is not. 

When to choose a simple equity investment agreement

You should consider the following differences in choosing whether to create a Convertible Note or a SAFE:

A 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;

A convertible Note carries interest, but a SAFE does not; and

A convertible Note identifies the minimum amount of funds to be raised at the equity financing, but a SAFE does not.

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.

How a SAFE Agreement helps early stage funding

Once founders form a startup is founded, the owners usually need money quickly. They have to fund their day-to-day operations and need capital to develop their ideas. Under conventional funding models, the founders would issue convertible promissory notes or hold a preferred equity round.

Since convertible promissory notes are a form of debt, they have various strict obligations. They have interest rates and maturity dates. Upon maturity, the startup has to pay the money back at interest or convert its value into equity in the company.

A round of equity funding avoids the problem of taking debt, but it comes with its issues. Holding a round of equity funding can be expensive and complicated. It forces the startup to perform a valuation before the company is established, which usually leads to a lower valuation and allows investors to take a larger piece of the company.

Key SAFE terms explained

Equity financing is defined in the SAFE as a “bona fide transaction or series of transactions with the principal purpose of raising capital, pursuant to which the Company issues and sells Preference Shares at a fixed pre-money valuation”.

There is no threshold or minimum amount for equity financing, unlike in a Convertible Note.

In the Zegal app, you have four options for how the SAFE will convert into preference shares when equity financing happens:

1. The price per preference share to be offered at the equity financing;

2. The price per preference share to be offered at the equity financing with a discount;

3. The price per share determined by a pre-negotiated valuation cap (see below); or

4. The lower of option 2 or option 3.

If you choose option 1 or option 3, the price at which conversion will take place will be called the “Safe price”.

If you choose option 2, the price at which conversion will occur will be called the “Discount price”.

If you choose option 4, the price at which conversion will take place will be called the “Conversion price”.

Equity agreements and valuation caps

A valuation cap is a pre-negotiated amount that caps the conversion price.

Without a valuation cap, the conversion price a SAFE converts into preference shares will be the price for preference shares at the equity financing (with or without discount, depending on your choice in the Zegal app).

With a valuation cap, the conversion price will be determined by the valuation cap, no matter how high the equity financing price is.

Liquidity price means either (i) a price determined by reference to the valuation cap; or (ii) if there’s no valuation cap, the fair market value of ordinary shares at the time of the liquidity event.

Pro rata rights are the rights of the SAFE investor to purchase more shares in the company if the company raises a further round or rounds of financing.

These rights are only exercisable after the SAFE has converted into preference shares of the company at the equity financing. 

For example, if you execute a SAFE before Series A financing, the SAFE is converted into preference shares of the company at Series A.

With the pro rata rights, the investor will be entitled to purchase more shares if the company raises a Series B financing, at the same price and on the same terms as the Series B investors.

How to create a simple agreement for future equity template:

Step 1: Create and execute a Simple Agreement for Future Equity (SAFE) on the Zegal app.

Step 2: The Investor pays the purchase amount simultaneously upon signing the Simple Agreement for Future Equity (SAFE).

Step 3: Create and execute a SAFE Pro Rata Rights Agreement on the Zegal app if applicable.

• Amount of investment that the investor will make;
• How the conversion price will be set;
• If applicable, what the discount rate for the investor will be;
• If applicable, what the valuation cap for the investor will be; and
• Whether you wish to give pro-rata rights to the investor.

Create a SAFE Agreement

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