SAFE as a Capital Raising Option for Startups: An Overview and Variations in Terms
Raising capital is one of the biggest hurdles for startups. Founders need funds to grow but often want to avoid giving away too much ownership or dealing with complex debt. One flexible, founder-friendly solution is the Simple Agreement for Future Equity (SAFE). Initially introduced by Y Combinator in 2013, SAFEs provide a straightforward way for startups to raise funds without immediate valuation discussions or diluting ownership right away.
Let’s break down how SAFE works, its key variations, and some examples of each.
Understanding SAFE Agreements
A SAFE is a simple agreement between a startup and an investor. The investor provides funds in exchange for the right to equity later, usually at the next funding round. It’s not a debt instrument (meaning there’s no repayment required), but rather a right to equity when the company raises its next round.
This combination of simplicity and deferred valuation has made SAFE popular among founders and investors alike. However, SAFEs come in several types, each with different terms and benefits. Here’s a look at each type, with examples to illustrate how they work.
Key SAFE Terms with Examples
Standard SAFE (No Discount, No Cap)
In this simplest form of SAFE, the investor’s funds convert to equity at the price per share in the next financing round, with no discount or valuation cap.
Example:
Scenario: A startup, BrightHealth, raises $100,000 from an investor using a standard SAFE with no discount or valuation cap.
Outcome: When BrightHealth raises its next round at a $10 million valuation, the investor’s $100,000 converts at the same valuation ($10 million) without any additional incentives.
Result: The investor receives equity in the company at the same price as new investors in the round.
Why Use It: This version is appealing to founders who want to keep things simple and avoid offering special terms. However, it may be less attractive to investors since they don’t receive any incentives.
Discount SAFE
A discount SAFE provides investors a discount on the share price in the next round, typically between 10-30%, as a reward for early investment.
Example:
Scenario: A startup, GreenGadget, issues a $50,000 SAFE with a 20% discount.
Outcome: GreenGadget’s next financing round is at a $5 million valuation. With the discount, the investor’s SAFE converts at an effective valuation of $4 million (20% lower than $5 million).
Result: The investor receives more shares than they would have at the regular price, as compensation for early risk.
Why Use It: This type of SAFE appeals to investors by guaranteeing a lower conversion price, rewarding them for their early support while allowing the founder to defer valuation discussions.
Valuation Cap SAFE
With a valuation cap, the investor’s conversion price is capped at a predetermined value, so if the company’s valuation in the next round is higher, the investor gets a better deal.
Example:
Scenario: A startup, AquaTech, issues a SAFE with a $3 million valuation cap, with an investor contributing $150,000.
Outcome: AquaTech’s next round is at a $6 million valuation. Because of the cap, the investor’s $150,000 converts as if the company were valued at $3 million, doubling their ownership.
Result: The investor benefits from a higher equity stake due to the capped valuation, providing strong upside if the company’s value increases.
Why Use It: Valuation caps are popular with investors because they secure a higher ownership percentage if the company’s valuation rises. Founders should choose the cap carefully to manage dilution effectively.
Valuation Cap and Discount SAFE
Combining both a valuation cap and a discount, this SAFE allows investors to use the more favorable of the two terms.
Example:
Scenario: A startup, Solarify, raises $200,000 using a SAFE with both a 15% discount and a $4 million valuation cap.
Outcome: Solarify’s next round is at an $8 million valuation. The investor’s SAFE will convert at either the discounted valuation ($6.8 million due to the 15% discount) or the $4 million cap—whichever is lower. In this case, the $4 million cap is more favorable.
Result: The investor’s SAFE converts at the $4 million valuation, maximizing their equity.
Why Use It: This combined option provides maximum incentives for early investors, making it easier to attract capital. Founders need to set cap and discount terms carefully to avoid excessive dilution.
Post-Money SAFE
In a post-money SAFE, the investor’s ownership percentage is determined after the SAFE money is added, giving a clear ownership percentage.
Example:
Scenario: EcoSolutions issues a $500,000 post-money SAFE with a $5 million post-money valuation cap.
Outcome: The investor’s ownership percentage is determined based on the $5 million total valuation, including their $500,000 investment.
Result: This approach provides investors with a clear picture of their ownership after conversion, while founders retain more control over the valuation.
Why Use It: Post-money SAFEs give investors certainty about their future ownership percentage, which can attract more serious investors. However, it can lead to more dilution for founders compared to pre-money SAFEs.
MFN SAFE (Most Favored Nation)
With an MFN provision, if the company issues more favorable terms in a future SAFE or convertible note, the investor’s terms will adjust to match.
Example:
Scenario: A startup, BioBloom, issues a $75,000 MFN SAFE to an early investor.
Outcome: Later, BioBloom issues a SAFE to a new investor with a 20% discount and a $2 million valuation cap. Thanks to the MFN clause, the initial investor’s SAFE updates to match the new investor’s 20% discount and $2 million cap.
Result: The first investor benefits from the better terms offered to later investors.
Why Use It: An MFN SAFE protects early investors by ensuring they benefit from any improved terms offered to subsequent investors. Founders should consider this option if they anticipate issuing future SAFEs with varied terms.
SAFE vs. Convertible Notes: A Quick Comparison
SAFE and convertible notes both delay equity conversion, but with some key differences. Convertible notes are debt instruments, meaning they have a maturity date and interest rates, creating repayment obligations if conversion doesn’t occur. SAFE avoids these complexities by focusing only on future equity conversion.
Concluding Thoughts
SAFE agreements can be powerful tools for startups seeking flexible, founder-friendly ways to raise capital. Each variation provides unique terms that can attract investors while deferring valuation discussions to a future date.
Deciding which SAFE terms to use involves balancing incentives for early investors with flexibility for future funding. Consulting with legal and financial experts is essential to understand the implications of each term and to ensure the SAFE aligns with the startup’s long-term goals.
Each SAFE variation offers tailored options that benefit both founders and investors, providing a flexible and efficient pathway to growth. With careful planning, SAFEs can serve as a vital stepping stone for startups on their journey to success.
