Simple Agreement for Future Equity (SAFE)A SAFE Note is an innovative form of convertible security that enables small business and startups to raise capital while postponing valuation.
A SAFE note refers to Simple Agreement for Future Equity, which was created by an accelerator, Y Combinator. It is an innovative form of convertible security that enable small business like startups to raise capital while postponing valuation, which improves capital efficiency. Like an IOU agreement, the SAFE note represents a more flexible agreement between the investor and a company. In exchange for upfront money, the investor gains the contractual right to acquire shares in the company in the future.
Generally, SAFE notes have no maturity date and no interest rate. They can help avoid fundraising gridlocks; close funding rounds efficiently; offer higher discount rates to investors; and, avoid premature valuations. But many SAFEs also include a valuation cap or maximum valuation threshold. This cap enforces a maximum value to which the SAFE can convert.
Mutual Benefits of SAFE Note
SAFE Notes enable companies to move quickly because investors don't have to do much due diligence (since they aren’t buying shares upfront). Thus, start-ups can acquire money fast, skip the traditional time-consuming processes, and give one document that sets out an agreement for the future. This right is subject to certain parameters set out in the SAFE. They are appealing for companies because they don’t give rise to issues of insolvency nor do they have the potential complexity around alternate debt funding. Further, they do not attract the same scrutiny as equity.
Process of SAFE Note
First, the investor agrees to give upfront cash payment to the company in return for contractual right to convert that amount into shares at a later date. At a later date, usually the closing of a priced equity round or liquidity event, the investor can choose to receive their investment amount back or convert that value into shares. In the context of shares, there is an automatic conversion process. The investment amount or share value depends upon the initial cash payment amount and the share price of the priced equity round or liquidity event. Akin to convertible notes, the company will issue discounted shares to reward the investor for their early cash injection.
Companies should proactively and fully understand the true cost/impact of issuing SAFE notes, before an investment is accepted. They should consider whether SAFE Notes are appropriate for future success or whether further notes are suitable for the current development stage. Issuer and investor awareness is essential for mitigating unwanted risk/impact.
Use this SAFE Note If:
You are a small or new business looking for investment, even if you are not generating revenue
You are an investor that wants to avoid the need to do due diligence and research
What does this SAFE Note Cover?
Right to be issued Shares
Waiver of pre-emptive rights
Voting and other rights
Compliance with law
Representations of Company and Investor
General considerations like notices, variation, assignment, etc