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January 9, 2019

How Safe are SAFEs?

SAFE refers to a “Simple Agreement for Future Equity.” Under the agreement between the founders and investors, investors receive a future stake in the company if the triggering event takes place. The triggering event can be a future round of funding, or a merger or acquisition.


SAFEs are another common security instruments in the world of crowdfunding. They were first introduced in 2013, and ever since, there has been no looking back. Many equity crowdfunding offerings issue SAFEs as the security instrument in exchange for the investment received.


Investors receive agreement for a future stake in the company and then wait for the conversion event to occur. If the conversion event does take place, they receive an equity stake in the company.


It makes early-stage investing simple and as efficient as possible.


How are SAFEs different from Convertible Notes


Investors investing in convertible notes are offering a loan to the company and they receive interest payments in return. However, in terms of SAFEs, investors do not receive any interest payments. At the same time, SAFEs are far less complicated than convertible notes. They do not include any maturity dates and other terms to be negotiated.


Advantages of SAFEs


SAFEs offer certain advantages over other security instruments. The most significant advantage is their simplicity. SAFEs are simple, short, and precise documents that leave few aspects to be negotiated. They do not have maturity dates or interest rates to be discussed and can be entered in the least amount of time.


SAFEs are also less time consuming and costly. Investors and founders do not have to spend a lot of time and money in formulating a long legal document. Legal fees associated with SAFEs are also limited. Founders do not have to pay interest freeing up capital for growth. At the same time, they are also under no pressure to work out a future financing deal.


Disadvantages of SAFEs


As previously noted, SAFEs are simple and uncomplicated. However, the lack of legal formalities and regulations also makes them susceptible to ambiguity and uncertainty. The lack of concrete terms of the agreement increases the chances of tension between investors and founders at the time of conversion.


Also, since the valuation cap is not always specified, investors can suffer from dilution of stake in the event of a future round of financing. SAFEs are not regulated and there can be many discrepancies. Not only to the investors, but SAFEs can also turn out to be harmful to the founders as well. When different SAFEs are issued at different prices, it impacts the capitalization of the company and may affect its financial viability.


Advantages

Disadvantages

Simple and Uncomplicated

Ambiguity and Uncertainty

Less Time and Money Consuming

Valuation Cap

Beneficial for Founders

Financial viability of the company


Bottom Line


SAFEs are one of the security of choice for equity crowdfunding. Startups need to move fast in making their idea or concept come to life and a SAFE is the best way to make this happen.


However, due to the lack of regulations and legal restrictions, SAFEs do not offer a lot of protection to the rights of investors. The conversion event may or may not occur and the stake of investors may also end up getting diluted. SAFEs can turn out to be harmful to the founders as well, if not executed well.


All in all, crowdfunding investors should perform due-diligence when considering a SAFE or any other crowdfunding investment.


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About: Chris Lustrino

A Boston College Eagle for life, on a mission to democratize startup investing for all people at KingsCrowd, with a passion for Fintech, investing, social impact, doing well and doing good, and an avid runner, cyclist and writer.

View Chris Lustrino's articles

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