The United States remains, undoubtedly, the leader in raising capital and finding new, innovative ways of doing so. In Australia, startups still raise capital through debt and equity, and increasingly convertible notes (a hybrid of debt and equity).
However, over the past twelve months, YCombinator, an accelerator in the United States, has introduced a new instrument called the ‘Simple Agreement for Future Equity‘ or the SAFE. Companies in other countries, including Australia, have taken notice of this new trend. So what is a SAFE and how does it compare with other forms of capital raising?
What is a SAFE?
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.
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.
How Does a SAFE Differ to Other Forms of Capital Raising?
|SAFE||Convertible Note||Debt (Loan)||Equity|
|Valuation Cap||Not required, however sometimes included.||Not required, however sometimes included.||No company valuation required, however may be relevant for securing the loan or providing security.||Pre-money and post money valuations are set for each round.|
|Document Required||SAFE only.||Convertible Note only.||Loan agreement and security agreement (if the loan is secured).||Subscription deed, shareholders agreement and share certificate.|
|Negotiation||Generally quick and easy to negotiate.||More involved than a SAFE. Includes negotiation of the debt elements (e.g. term of the loan and interest).||Less room to negotiate. Strong lender protections are included.||Can be more time consuming and complex to negotiate (e.g. valuation, investors rights, shareholders agreement and company warranties).|
|Term||N/A – this means there is no need to track or negotiate deadlines. If the company never reaches the trigger event, no shares are issued.||Yes – Convertible Notes will have a maturity date at which the loan will either need to be repaid or convert to equity at a predetermined rate.||Will commonly specify a repayment date or repayment schedule.||Subscription funds are given to the company without any term for repayment.|
|Interest||N/A||Can be included but not required.||Almost always included.||N/A|
|Regulation||Regulated under the Corporations Act as an offer of securities.||Regulated as a debt instrument and under the Corporations Act as an offer of securities.||Regulated as a debt instrument.||Regulated under the Corporations Act as an offer of securities.|
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:
- 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;
- 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:
- term of the loan;
- whether the founders must pay interest on the loan; and
- whether the startup is to grant security in respect of the loan;
- Simplicity usually means lower costs (particularly legal fees);
- 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;
- Founders do not pay interest on SAFEs and therefore avoid the complexities involved in converting interest into equity; and
- SAFEs are not debt instruments. As such, they are not regulated as a debt and do not create the threat of insolvency for your startup.
The SAFE has already gained a considerable amount of interest in Australia. However, we are still not seeing many startups raise a round using SAFEs just yet. Investors may require some time to familiarise themselves with the instrument before we see it gain traction, and in time even replace the convertible note. If you are considering raising a round using a SAFE and have any questions, get in touch with our startup lawyers on 1300 544 755.