There are different instruments and financing options when it comes to raising capital for a business. SAFEs (or Simple Agreement for Future Equity) have been one of the more dominant options since Y Combinator introduced them in 2013.
As a founder it is important to know what financing options and instruments are available to your business. Learn more about SAFEs and what they mean when it comes to a fundraise below:
Related Resource: All Encompassing Startup Fundraising Guide
Note: We suggest consulting a lawyer when determining what financing options are right for your business.
What Does SAFE Stand For?
SAFE is short for Simple Agreement for Future Equity. As we mentioned above SAFEs were introduced in 2013 by Y Combinator and are here to stay. SAFEs are a type of convertible instrument that converts to equity at a later date. This means a founder is promising equity in their company at a later date when a founder goes out to raise money on a priced round.
As Paul Graham put it in the 2013 blog post announcing SAFEs, “A safe is like a convertible note in that the investor buys not stock itself but the right to buy stock in an equity round when it occurs. A safe can have a valuation cap, or be uncapped, just like a note. But what the investor buys is not debt, but something more like a warrant. So there is no need to fix a term or decide on an interest rate. Safes should work just like convertible notes, but with fewer complications.”
Related resource: The Startup's Handbook to SAFE: Simplifying Future Equity Agreements
The Difference Between SAFE Fundraising and Other Types of Investment Rounds
While SAFEs are popular in the market there are other funding options that can be compared to them. Learn more about how SAFEs stack up against other funding instruments below:
Related Resource: How to Secure Financing With a Bulletproof Startup Fundraising Strategy
Note: We suggest consulting a lawyer when determining what financing options are right for your business.
SAFE vs. a Priced Round
One alternative to a SAFE is a priced round. As the team at Vincent puts it, “A priced round is an equity-based investment round in which there is a defined pre-money valuation. This means that before completing the investment, the asset has a valuation and, thus, a price-per-share. In Venture Capital, priced rounds are the most common investment structure.”
This means that a company has a determined valuation when working through a priced round. As for a SAFE, you are setting a valuation cap to hit in the future. Because of this, SAFEs only require you to negotiate 2 things when raising:
- How much money the investor will put into the company
- What is the valuation cap
On the flip side, a priced round will require more negotiations as you are determining a valuation.
SAFE vs. a Convertible Note
Another funding option is a convertible note or convertible debt. As the team at Investopedia writes, “A convertible note is a debt instrument often used by angel or seed investors looking to fund an early-stage startup that has not been valued explicitly. After more information becomes available to establish a reasonable value for the company, convertible note investors can convert the note into equity. Investors have the option to exchange their notes for a predetermined number of shares in the issuing company.”
How Do SAFEs Work?
Of course, when seeking out to raise using a SAFE you should be able to understand the components of a SAFE. When looking at the document from the team at Y Combinator there are only 5 sections (link to the Y Combinator documents here):
- Section 1 — Events
- Equity financing – This explains what happens in the event of equity financing
- Liquidity event – This explains what happens in a liquidity event
- Dissolution
- Liquidation priority – who comes first to be repaid in the listed events above.
- Section 2 — Definitions
- Section 2 will help you understand the different language and terms used throughout the document. A few of the key terms from section 2:
- Section 3 — Company Representations
- Section 4 — Investor Representations
- Section 5 — Miscellaneous/Legal Language
We encourage founders to check out the document from Y Combinator above as they offer definitions and thorough breakdowns of how SAFEs work.
How Do SAFEs Benefit Investors?
SAFEs have not picked up in popularity by luck. SAFEs can be a beneficial instrument for both investors and founders. In order to understand if SAFEs are right for your business, you need to understand how they work from the investor’s perspective.
A Streamlined Process to Acces Early-Stage Investments
Due to the ease of negotiations when it comes to raising via a SAFE, investors are able to see more deals. For example, if an investor is constantly negotiating with potential companies, they will be hindered when it comes to deploying capital in an efficient way.
Ability to Convert Investments into Equity
Investors also have the ability to convert their investments into equity. Because of the valuation cap and discount rate, investors can convert their equity at better terms than newer investors.
How Do SAFEs Benefit Founders?
Of course, SAFEs only make sense if they are beneficial to you as a founder as well. As we’ve previously mentioned the main benefit of SAFEs is their simplicity for both founders and investors. However, there are a few other benefits:
Enhanced Flexibility With Shareholders
When making an investment via a SAFE, investors are not entitled to voting rights and rights that might create interference and additional work on a founder.
Faster Access to Financing
Speed is crucial when it comes to building and financing your business. SAFEs are a great tool to speed up a financing round and allow founders to get back to what matters the most, building their business.
3 Questions to Ask Before You Raise a SAFE
Before going out a raising a SAFE, there are a series of questions you should be able to confidently answer. As we’ve previously mentioned in this post, we suggest consulting a lawyer when determining what financing options are right for your business.
1) Are You Willing to Give Up Equity?
First and foremost, you need to ask yourself if you are willing to give up equity. Although you are not giving it up in the immediate, you ultimately are promising to give up equity at a later date. While it can be tricky to determine exactly how much you’ll be giving up, it is important to meet with lawyers and financial advisors to model how much you will be giving up.
2) Are You Considering Raising Money in Your Next Priced Round?
Seeing the future, especially as a startup founder, can almost feel impossible. But when it comes to a SAFE you should have an idea of how much you would like to raise in a future priced round. This way you’ll be able to avoid over diluting future investors and keep all parties involved happy.
3) How Will You Track Your SAFE Investments?
Of course, you’ll need to a way to track your SAFE and manage your cap table after closing a SAFE. We recommend using a cap table management tool, like the tool from the team at Pulley.
Learn More About SAFEs & Fundraising
SAFEs are one of the many funding options available to you as a startup founder. No matter what instrument or vehicle you determine is right for your business, you need to have a gameplan in place to find, nurture, and close potential investors. Learn more about how Visible can help you with your next fundraise here.
