The Simple Agreement for Future Equity: a SAFE Way of Raising Capital

In Short

• SAFE Definition: A Simple Agreement for Future Equity (SAFE) allows investors to provide funds to a company in exchange for the right to convert the investment amount into shares on the occurrence of a pre-agreed future event (usually an equity round or exit event).
• Flexible Capital Raising: SAFEs are easier to negotiate and don’t require immediate company valuation, making them attractive to early-stage investors and startups.
• Non-debt Investment: Unlike loans, SAFEs are not debt instruments and do not attract interest. Thus, lowering financial pressure on startups.

Tips for Businesses

Consider SAFEs if you’re a startup seeking quick capital without valuing your company upfront. This method offers flexibility, fewer formalities, and no debt, making it a suitable choice for early-stage funding rounds.

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Table of Contents

• What is a SAFE Note?
• How Does a SAFE Differ to Other Forms of Capital Raising?
• What are the Advantages of a SAFE?
• Key Takeaways
• Frequently Asked Questions

The United States remains, undoubtedly, the global leader in capital raising and finding new, innovative ways of doing so. A few years ago, YCombinator, an accelerator in the United States, introduced a new instrument called the ‘Simple Agreement for Future Equity‘ or the SAFE Note. It quickly became extremely popular as a quick, cheap and straightforward way for startups to raise capital. Companies in other countries, including Australia, took notice of the trend, and SAFEs have now become commonplace in many jurisdictions. So what is a SAFE Note and how does it compare with other forms of capital raising?

What is a SAFE Note?

Essentially, a SAFE is a convertible loan without the debt element. Under a SAFE, an investor agrees to make a cash payment (which is not a loan) to a company in exchange for a contractual right to convert that amount into shares when a pre-agreed trigger event occurs. The trigger event is usually the closing of a priced equity round. Following a liquidity event, an investor can usually choose to either receive their investment amount back or convert that value into shares.

The number of shares the investor receives on conversion depends on the amount of the upfront cash payment and the share price of the priced equity round or the liquidation event (as applicable).

As with convertible notes, the startup will issue shares at a discount to the share price of the equity round or liquidation event to reward the investor for backing the company early. The discount price generally refers to the price per share of the equity or liquidation event multiplied by the discount rate.

Using a SAFE means, technically, you can delay valuing your company. However, like convertible notes, some SAFEs will have a valuation cap or a maximum valuation at which the amount will convert. So, parties are actually negotiating a valuation when raising the round under a SAFE that has a valuation cap.

As the SAFE is not debt, if there is an insolvency event before the cash converts to shares, then the startup usually agrees to pay the investor an amount equal to its cash injection before making any payments to its shareholders.

When using a valuation cap, it is essential to consider whether the valuation cap will be a post-money valuation cap or a pre-money valuation cap. A pre-money valuation cap means that SAFEs are diluting each other as well as the existing shareholders. A post-money valuation cap means that all SAFEs just dilute the existing shareholders (not each other), meaning that the SAFEholders end up with more of the company. 

How Does a SAFE Differ to Other Forms of Capital Raising?

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What are the Advantages of a SAFE?

There are many advantages of raising capital using a SAFE as opposed to other forms of capital raising, including:

1. SAFEs are quicker and easier to negotiate. There is no need to agree on a pre-money valuation (although the investor may want to negotiate a valuation cap), and the only document required is a short, SAFE instrument;
2. the SAFE is comparatively easier to negotiate than a convertible note because there are fewer terms. The convertible note is a debt instrument, and so parties must negotiate the usual debt provisions including:
   1. term of the loan;
   2. whether the founders must pay interest on the loan; and
   3. whether the startup is to grant security in respect of the loan;
3. simplicity usually means lower costs (particularly legal fees);
4. SAFEs, unlike a convertible note, do not have a term. This means that you are not subject to a major financing deadline that is not directly related to your company’s performance. You do not have to track the deadlines for each of your convertible notes or renegotiate deadlines if you do not close an equity round before the deadline. You just need to look at your runway to determine the company’s financial position. Furthermore, if a trigger event never occurs, then the investor will never actually receive shares in the company;
5. founders do not pay interest on SAFEs and therefore avoid the complexities involved in converting interest into equity; and
6. SAFEs are not debt instruments. As such, they are not regulated as debt and do not create the threat of insolvency for your startup.

However, there are a few key disadvantages to using a SAFE, including:

• as SAFE holders do not hold shares, they are usually not party to the Shareholders Agreement and therefore, are not bound by the rights and obligations found in the Shareholders Agreement; 
• for the investor, as SAFEs are not debt, they will rank below all creditors; and 
• if you are entering into multiple SAFEs over a long period of time, it is essential to try to keep the key terms of your SAFEs aligned (such as whether the SAFEs use a post-money or pre-money valuation cap). Otherwise it can become very complicated to work out the conversion mechanisms.

Key Takeaways

The Simple Agreement For Future Equity (SAFE) has become increasingly popular in Australia in recent years. We are now seeing a lot of startups raising rounds using SAFEs from a wide variety of investors, including top venture capital funds.

If you are considering raising a round using a SAFE and have any questions, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions