SAFE Equity stands for Simple Agreement for Future Equity. It is an agreement between the company and the investors under which the investors receive a future stake in the company when a pre-specified conversion event occurs.
History of SAFE Equity
SAFE Equity was first introduced by Y Combinator’s Legal Dream Team in late 2013 as an alternative instrument for raising funds by the startups. It worked as warrants to ensure a simple, easy, and fast means to raise funds. The investors get to invest in an early-stage company and get a future stake in the company on conversion. The conversion event can be a future round of funding, IPO or acquisition.
When introduced, the pricing of SAFE equity was done pre-money. However, after several changes in the equity crowdfunding industry, the calculation of SAFE Equity is now done post-money, i.e. the ownership of the SAFE holders is measured after the SAFE money is taken into account.
One platform that often uses the SAFE is Republic. If you want to learn more about their specific SAFE, check out this piece written by legal counsel, Max Rich.
What is the purpose of SAFE Equity in crowdfunding?
SAFE Equity has become one of the most common instruments for raising funds in equity crowdfunding. When it began in 2013, SAFE equity was the method to get the first money into the company and has been expanded to be utilized in seed rounds as well.
Many startups and investors are opting for SAFE equity as it is simple and therefore quick to implement for a round. SAFE equity is a one-document, uncomplicated instrument, without hundreds of terms to negotiate. This makes it easier for both the investors and companies to work with SAFE equity. The only point to be negotiated is the valuation cap. The intent behind SAFE equity is to remain fair to both the investors and the entrepreneurs.
In addition, SAFE Equity offers high-resolution fundraising, which means that the company can close the deal with an individual investor as soon as they are ready. The deal does not need to be closed with all investors simultaneously.
The SAFE equity agreement specifies the valuation cap for the conversion of the SAFEs to equity to prevent dilution. It also offers discounts to SAFE investors for purchasing the common stock of the company at later stages.
There are terms and conditions about the conversion of SAFE equity to a future stake in the company on the occurrence of the conversion event. The terms also include the information regarding what will happen if the startup fails and the company gets liquidated.
How is SAFE Equity different from other instruments?
At times, SAFE Equity may be confused with convertible notes. However, both the instruments do vary. Convertible loans consist of the money that the investors loan to the company and get interest payments on it (though technically this rarely if ever actually occurs). On the other hand, SAFE Equity is not a loan, and the investors do not receive interest payments.
Convertible notes have maturity dates whereas SAFE Equity does not. Therefore, there are more negotiations involved in working out convertible notes as the investment instrument. As compared to the other instruments as well, like loans or equity, SAFE Equity is less complicated and less time-consuming.
What are the Pros of SAFE Equity?
SAFE Equity has numerous benefits over the conventional instruments of raising funds. Some of the most significant advantages of SAFE Equity are:
Simplicity: The most important advantage of SAFE equity is its simplicity. The agreement documents are short and precise, as opposed to the intricate and lengthy documents associated with the other modes of raising funds. They do not have a maturity date or an interest rate, so there is little to be explained and negotiated.
Less cost and time: Due to the simplicity associated with SAFE Equity agreements, they take less time to close. Funds can be raised by the entrepreneurs when needed, without spending a lot of time on the legal details.
Founder friendly: Since SAFE equity agreements don’t have a maturity dates, the founders are not under any pressure to work out a financing deal in a limited time frame that may not be best for the company. Founders also do not need to pay interest on SAFEs and are not under the insolvency threats by debt holders.
What are the Drawbacks of SAFE Equity?
Many people have strong opinions around SAFE equity and there is validity to that. Below are some of the drawbacks of it.
Valuation cap: In most of the SAFE equity agreements, the pre-money and post-money valuation cap are not specified. Due to the ambiguity and uncertainty, many investors face much more dilution than they signed up for. The small SAFE rounds have an unprecedented impact on the future valuation of the company and cause dilution implications.
Financial viability of the company: Not only is this arrangement potentially harmful to the investors, but also for the entrepreneurs. If the founders issue multiple SAFEs at different valuation caps, it impacts the capitalization table of the company and can impact the financial viability of the company negatively.
Lack of concrete terms: It has been observed that SAFE equity agreements are uncomplicated with very few terms to negotiate, however, the same turns out to be a double-edged sword at times. Due to the lack of concrete terms, such agreements can create tension between the investors and founders, especially at the times of conversion.
Thus, SAFE equity is an unique, innovative, and simplistic instrument for raising funds. However, the investors and founders need to be vigilant and careful while entering into the SAFE agreements to ensure that the investment and the funding do not turn out to be awry and complicated at the later stages.
Be sure to consider all of these aspects when considering an investment that utilizes a SAFE.