A Simple Agreement for Future Equity (SAFE) is an increasingly popular way for Australian startups to raise capital. Y Combinator introduced it in the United States, and many startups have adopted an Australian version of the SAFE. It is an alternative to the more traditional equity raise (cash for shares) and has a similar form to a convertible note.

To help you understand how a SAFE operates, we have broken down its key terms below.

Investment or Purchase Amount

The investment or purchase amount is the amount of money the investor pays to the company upon entering into the SAFE. The SAFE will contain an obligation on the investor to pay this amount to the company immediately upon the execution date and will also sometimes specify the type or means of payment (e.g. a bank transfer).

Conversion Event

In return for their investment, the investor receives a contractual right to convert their investment money into shares in the company upon the occurrence of a conversion event. There are two main types of conversion events: a qualifying round and an exit event.

A qualifying round is an equity fundraising event (or series of events) by the Company with the primary purpose of raising capital. In short, it is the next round of traditional capital raising (not another SAFE round). At the qualifying round, the company will issues shares to the investor in return for their investment under the SAFE along with the other investors in that round.

An exit event encompasses a few different scenarios. It includes:

  • The sale of all or substantially all of the assets of the company (a business sale),
  • The sale of all or substantially all of the shares in the company (a share sale),
  • An initial public offering (IPO) on a recognised stock exchange; or
  • Anything else which has the effect of selling the business.

Generally, at an exit event, an investor will have the option to get their investment back or convert their investment into shares. The investor can then, as a shareholder, participate in the exit event along with all other shareholders.

Conversion Price

When a conversion event occurs, the investor will receive the number of shares equal to their initial investment divided by the conversion price. The conversion price at a qualifying round is generally the price per share at the time of the qualifying round multipled by a discount. At an exit event, the conversion price is generally the fair market value of the shares (and if the exit event is a share sale, the price per share connected with the share sale) multiplied by (1 minus the discount rate).

While a discount is not required, it is a very common feature of a SAFE. A discount rate of 15% means that the investor receives 15% more equity in the company than if they had been participating in the conversion event directly. A discount of between 10-20% is standard. As a SAFE is not a debt instrument (the investor may never get their money back if the company doesn’t reach a conversion event), it is considered riskier than a traditional equity investment. Therefore, the discount acts as a way to reward investors for taking the risk.

Valuation Cap

Some SAFE documents include a valuation cap. A valuation cap is essentially a pre-agreed valuation of the company. Often startups opt for a SAFE to avoid having to value the company. So, including a valuation cap can reduce the appeal of a SAFE. If there is an inclusion of a valuation cap at a qualifying round, the investor will either receive the number of shares calculated by the round price or by reference to the valuation cap, whichever is higher. This protects the SAFE investor from the company raising their next round at an overly high valuation and the investor essentially receiving very little for their investment.

Termination

A SAFE does not have an expiry date. It is drafted to terminate at the time the conversion of the investment into shares or when the company pays the investor back in full.  

Other Terms

The SAFE should contain many other operative terms, covering things such as:

  • What happens to the investor’s investment if the company goes into liquidation,
  • What rights does the investor have as a SAFE holder (essentially this is no shareholder rights),
  • Company and investor representations and warranties; and
  • Confidentiality protections.

Key Takeaways

There is no standard form SAFE that a company or investor must use under the law. For this reason, each SAFE has the potential to be very different. While you should expect to see the above terms in a standard SAFE you should carefully review your specific agreement. It is important to ensure that you understand how it operates and whether it reflects your understanding of the deal. If you have any questions or need to review or draft a SAFE for your company or investment, get in touch with LegalVision’s startup lawyers on 1300 544 755.

Madeleine Hunt
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