Overview of a SAFE Pro Rata Rights Agreement
What is a SAFE Pro Rata Rights Agreement?
A SAFE Pro Rata Rights Agreement is a letter by which a company gives pro rata rights to a SAFE investor.
By using a SAFE Pro Rata Rights Agreement, a SAFE investor has the right to purchase more shares in a company if the company raises a further round or rounds of financing.
The rights under a SAFE Pro Rata Rights Agreement is only exercisable after the SAFE has converted into preferred shares of the company at equity financing.
What is a SAFE?
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 occurrence of specific events. There are three possible scenarios:
- if the company achieves “equity financing”, the investor will receive preferred shares with the same rights and preferences as the preferred shares to be issued by the company at the equity financing (in which case the conversion price will be the “Safe price”. See below);
- 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); or
- 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 has no way to get his money back, unless otherwise agreed between the company and the investor.
A SAFE is similar to a Convertible Note in that 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. 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.
Key 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 Preferred 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 preferred shares when an equity financing happens:
- the price per preferred share to be offered at the equity financing;
- the price per preferred share to be offered at the equity financing with a discount;
- the price per share determined by a pre-negotiated valuation cap (see below); or
- 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 take place 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”.
Valuation cap is a pre-negotiated amount which serves to “cap” the conversion price. Without a valuation cap, the conversion price at which a SAFE converts into preferred shares will be the price for preferred shares at the equity financing (with or without discount, depending on the choice you make 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 preferred shares of the company at the equity financing. For example, if you execute a SAFE prior to Series A financing, the SAFE is converted into preferred 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.
In the Zegal app, you have the option whether or not to give the investor pro rata rights.
How to create a SAFE
Step 1: Create and execute a Simple Agreement for Future Equity (SAFE) on the Zegal app.
Step 2: Investor pays the purchase amount simultaneously upon signing the Simple Agreement for Future Equity (SAFE).
Step 3: If applicable, create and execute a SAFE Pro Rata Rights Agreement.
Key points included
- Date of the Simple Agreement for Future Equity (SAFE);
- Amount of investment that the investor has made; and
- Within how long can the investor exercise the pro rata rights.
