SIMPLE AGREEMENTS FOR FUTURE EQUITY (SAFES): A FLEXIBLE FINANCING TOOL FOR STARTUPS

The Simple Agreement for Future Equity (SAFE) is a seed financing tool that has gained popularity among startups, particularly those participating in the Y Combinator accelerator program. SAFEs offer an attractive alternative to convertible notes, especially for startups that are wary of issuing debt due to concerns about reaching the maturity date before concluding a Next Equity Financing. This article delves into the structure, benefits, and considerations of SAFEs, highlighting their role in early-stage startup financing.

WHAT IS A SAFE?

A SAFE is an agreement between an investor and a startup that provides the investor with the right to future equity in the company without specifying a set date for conversion or accruing interest. SAFEs are designed to simplify the fundraising process and reduce the costs associated with raising capital at the seed stage.

Key Features of SAFEs:

No Maturity Date: Unlike convertible notes, SAFEs do not have a maturity date. This means they remain outstanding indefinitely until a conversion event occurs.
No Accruing Interest: Investors in SAFEs do not earn interest on their investment. Instead, they receive the right to convert their SAFEs into equity at a lower price than future investors based on a discount rate or valuation cap.

CONVERSION FEATURES

SAFEs share the same conversion features as convertible notes, providing flexibility and aligning investor interests with those of future equity investors. They convert into stock upon the occurrence of specific events, using similar mechanics to convertible notes.

Conversion Events:

Next Equity Financing: When the company raises its next round of preferred stock financing, the SAFE converts into shares of the same series of preferred stock that the new equity investor purchases, at a discounted price or valuation cap.
Corporate Transaction: If the company is sold before the next equity financing, the SAFE can convert into common stock or be repaid, depending on the terms negotiated.
Other Events: Depending on the specific terms of the SAFE, other conversion triggers such as reaching specific milestones or timelines may also apply.

PRE-MONEY VS. POST-MONEY SAFES

There are two primary forms of SAFEs: pre-money and post-money. The choice between these forms has significant implications for both investors and founders.

Pre-Money SAFE:

Definition: A pre-money SAFE does not include the conversion of the SAFE when calculating the ownership percentage for the investor. This means the SAFE converts based on the company’s valuation before considering the new investment.
Implications: Pre-money SAFEs are generally considered more founder-friendly because they do not set a fixed ownership percentage for investors, thus allowing founders to retain more control over future dilution.

Post-Money SAFE:

Definition: A post-money SAFE includes the conversion of the SAFE when calculating the ownership percentage for the investor. This sets a fixed ownership percentage for the investor upon conversion.
Implications: Post-money SAFEs provide greater clarity on the investor’s ownership percentage, making them more investor friendly. However, they put founders at greater risk of future ownership dilution.

BENEFITS OF USING SAFES

Simplicity and Cost-Effectiveness: SAFEs typically involve fewer terms to negotiate and shorter contracts, resulting in lower legal fees and faster fundraising processes. This makes them an attractive option for early-stage startups looking to raise capital quickly and efficiently.

Flexibility: Without a maturity date or accruing interest, SAFEs offer flexibility to startups. They can remain outstanding indefinitely until a suitable conversion event occurs, reducing pressure on startups to achieve specific milestones within a set timeframe.

Alignment with Investor Interests: By providing a clear path to equity conversion, SAFEs align investor interests with those of future equity investors. This ensures that early investors are rewarded for taking on additional risk during the startup’s initial stages.

Considerations for Startups

While SAFEs offer numerous benefits, startups should carefully consider the implications of using pre-money versus post-money SAFEs. The choice can significantly impact future ownership dilution and control over the company’s equity structure.

Founder-Friendly Pre-Money SAFEs: Pre-money SAFEs are generally more favorable to founders as they do not set a fixed ownership percentage for investors. This allows founders to manage future dilution more effectively, retaining greater control over their company.

Investor-Friendly Post-Money SAFEs: Post-money SAFEs provide greater certainty for investors regarding their ownership percentage, making them more attractive to potential backers. However, they can lead to more significant dilution for founders in future funding rounds.

CONCLUSION

Navigating the startup lifecycle requires a clear understanding of each stage’s unique challenges and opportunities. From the initial idea to maturity and exit, each phase presents different financing needs and options. At GNS Law, we specialize in guiding startups and their investors through these critical stages, ensuring they have the right financial strategies in place to support growth and success.

At GNS Law, we represent US and LATAM venture capital funds, private equity funds, and startups. For more information, contact us at info@gnslawpllc.com.

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