What is a SAFE Agreement?
A SAFE Agreement 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.
How to create a SAFE Agreement
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What are the advantages of raising capital through the SAFE Agreement?
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 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 deadlines. If the company never reaches the trigger event, no shares are issued.
Are SAFE agreements debt or equity?
SAFE agreements are not debt instruments. They are quite similar to convertible notes in the sense that they both provide equity to the investor during a future preferred stock round, but SAFEs do not accrue interest or have a specific maturity date. In fact, SAFE’s may never be triggered to convert into equity.
Why are the risks of SAFE notes for investors?
A SAFE agreement 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 at an accounting level as a convertible note is a debt instrument whilst a SAFE is not. There is also the chances a SAFE will never convert into equity and investors won’t get back their money.
What are the differences between a SAFE agreement 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 a convertible note.
- 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.
- A convertible Note identifies the minimum amount of funds to be raised at the equity financing, but a SAFE does not.
How does a SAFE work? What are its key clauses?
A SAFE has certain key clauses and characteristics that make it work.
- Valuation caps: This ensures that SAFE investors get a better deal than other investors who join in later by capping the maximum valuation at which a SAFE can convert into equity.
- Discounts: Early investors are incentivized with SAFE discounts. This is a valuation discount that early investors receive that is not given in the following financing round.
- Most Favoured Nation (MFN) Clause: this clause is put in place to keep the investors who come in later from being able to get much better terms in comparison to the earlier investors.
- Pro-Rata Rights: later stage funding round investors can disturb the ownership percentage in a company. Pro-rata right gives SAFE investors the opportunity to continue maintaining their ownership percentage in the company.
All in all, when all the involved parties agree to the terms are agreed of the SAFE, the investor sends through their half of the agreed-upon funds. Finally, when any of the listed events are triggered, the investor is able to get the equity (SAFE preferred stock).
Why is SAFE important for startups?
Startups could always do more with more investment, hence, SAFEs are important for startups to help raise money. But, they are equally important for a startup for other reasons too. For one, they are quite simple to create and implement. Further, they do not come with the additional baggage of interest. They help to avoid debt, time-consuming paperwork, and legalities too. Hence they can be quite important for startups.
When does an investor actually get the shares?
A SAFE has various events which lead to the conversion of the investment into shares. These are also known as trigger events. The amount or number of shares an investor will get depends on the agreement between the parties.
Events governing the SAFE
SAFE is an ‘ easy to execute’ financial instrument, but they only yield results when specific events are triggered. Here are common events that often govern SAFE.
- Equity financing: SAFE will mostly always have details of what happens if an equity financing round takes place. It needs to be specific about if and how the investor will be paid the value of their share following equity financing.
- Liquidity event: SAFE should mention what will happen in the event of liquidity as companies could be sold before the shares mature.
- Dissolution: Business is a risk and there is a chance the company could go bankrupt before the conversion of SAFE to equity shares. The rights and obligations in such an event have to be covered in a SAFE.
Can an investor ever get money back, instead of shares?
SAFEs do not work the same way loans do. Investors are generally unable to cash out directly. However, this is not rigid and depends upon the agreement between the companies and investors. The two can discuss and negotiate circumstances under which investors could be entitled to receive the money they put in. There are exceptions for this as it doesn’t apply to SEIS/EIS investments.
What could go wrong with SAFEs?
There are a lot of benefits to weigh in favor of SAFE. However, investors can at times find that SAFE offers lesser or more limited protection than a direct investment. Investors might not receive warranties in a relatively short and simple SAFE. As it is usually during the earlier stages it also comes with more associated risks too.
A SAFE Agreement 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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