If you follow startups, you’ve probably heard of convertible notes and Series A financings, but the newest item is the SAFE – the Simple Agreement for Future Equity. SAFE is a seed-stage financing tool that provides a lower-cost, speedier alternative to convertible debt financings. SAFE was devised by Y-Combinator partner Carolynn Levy, who is also an attorney. The SAFE documents are designed to be short (about 5 pages, which is short for legal documents), and fairly standardized.
Y Combinator describes SAFE as “essentially convertible debt without the debt.” A convertible note is a loan that converts into equity in a company when certain events occur. When an investor uses SAFE, he is buying the right to obtain preferred stock when an equity-financing round occurs. It’s more like a warrant than debt. And unlike a convertible note, you don’t need to specify a term or an interest rate. When a convertible note reaches its maturity date without another financing round in sight, the startup needs to negotiate with the investor to extend them term. No such problem with SAFE. You also don’t necessarily need a valuation cap with SAFE, which can make the financing faster and less expensive. The SAFE document specifies that when an equity financing round occurs, the holder of the SAFE has the right to get preferred stock, based on his investment and the discount rate. If there is an acquisition or an IPO, the SAFE holder can either get his money back, or convert the SAFE to common stock.
Y Combinator has provided 4 variations of SAFE:
- SAFE Cap, No Discount
- SAFE Discount, No Cap
- SAFE CAP and Discount
- SAFE MFN, No Cap, No Discount
Cap refers to the valuation cap, as you probably already figured. Discount refers to the discount rate, which enables the SAFE investor to obtain a more favorable price for equity to compensate for the greater risk of investing early. For example, let’s say there’s a discount rate of 20%. When the next equity financing round occurs, if the new investors are buying in at $1/share, the SAFE investor gets to buy in at $0.80 per share. So the new investor gets 100,000 shares for $100,000, while the SAFE investor gets 125,000 shares for $100,000.
MFN means “most favored nation.” Let’s say a startup issues a SAFE MFN, with no cap or valuation discount, and then later issues a SAFE upon better terms to the later investors (for example, the later SAFE has a discount or a valuation cap). The SAFE MFN will be amended to include the more favorable terms from the later SAFE.
There are two important things to keep in mind with the SAFE. First, they are still securities, and therefore covered by the securities laws. While the documents are relatively straightforward, as legal documents go, it’s still worth talking with your lawyer before doing a SAFE financing. Second, the SAFE does go on your cap table, just like a warrant or option.