A Simple Agreement for Future Equity (SAFE) is a convertible instrument used by startups to raise capital. Unlike traditional equity or debt, a SAFE is a simple contract that gives investors the right to receive equity in your company at a future date, typically when your company raises money at the next priced round. This article will explore the various ways to structure your SAFE round with an Australian VC Fund and key areas to negotiate.
Understanding SAFE Agreements
SAFEs are designed to be flexible and straightforward. This allows you to defer determining the Company’s valuation (i.e., an exact price per share) until a later funding round. This is why SAFEs are popular with early-stage companies. They offer a faster, less expensive way to raise capital than traditional equity rounds.
A SAFE is designed to align with the fast-paced nature of startups. This enables founders to secure funding without lengthy negotiations with Australian VC funds. Additionally, Australian VC funds appreciate the potential upside of SAFEs, such as receiving shares at a discount when the SAFE converts to equity.
SAFE Round Structure
A common pitfall to avoid is the temptation to stack multiple SAFE rounds, especially when the terms vary. While it might seem advantageous to secure funding from different investors at different times, this approach can lead to significant complications down the line.
Ideally, a Company should limit its SAFE rounds to one or two, all under the same commercial terms (e.g., pre-money or post-money valuation, discount rate, and valuation cap). This streamlined approach simplifies cap table management and makes future equity conversions more straightforward. It also presents a cleaner, more attractive investment opportunity for subsequent funding rounds.
Continue reading this article below the formKey Commercial Terms in SAFE Rounds with Australian VCs
Discount Rate and Valuation Cap
When structuring your SAFE round, start with the key commercial terms, such as the discount rate and the valuation cap. The discount rate, typically around 20%, gives early investors a lower price-per-share in future rounds priced at a premium. The valuation cap sets a fixed ceiling on the SAFE’s conversion value, providing investors with certainty about the maximum value at which their SAFE will convert.
Timing plays a critical role in determining these terms. Consider when you will need to conduct your next priced round, and estimate your company’s future valuation at that point. For instance, if you’re planning a priced round in just three months, a 20% discount might be overly generous, as it could result in a substantial uplift for investors in a short timeframe. Similarly, setting a low valuation cap for your Company (e.g., $1 million) would not be advantageous if you expect to raise $10 million within a year.
Pre-money and Post-money
Another key commercial term to decide is whether the SAFE is on:
- Pre-money Basis: A “post-money SAFE” includes the shares issued on conversion when calculating the company’s fully diluted capital. Investors often prefer this structure because it gives them greater certainty about their eventual ownership; or
- Post-money Basis: A “pre-money SAFE” means that shares issued upon conversion of the SAFE are not included in the fully diluted capital. This means founders will often experience less dilution with a pre-money SAFE than with a post-money SAFE.
Qualifying Financing Round
Companies may negotiate a minimum qualifying financing round threshold in SAFEs, specifying the minimum amount to be raised in a priced round for the SAFEs to automatically convert. For example, the Company must raise at least $1 million in its next priced round for the SAFEs to convert.
Maturity Date and Interest Rate
Unlike a convertible note, a SAFE does not accrue interest and typically lacks a maturity date, so there is no specific deadline for conversion or repayment. The agreement does not include complex repayment terms or collateral requirements often associated with debt instruments.
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Shareholder Rights and Director Appointment
When an Australian VC fund invests in your company through a SAFE, it is crucial to understand the limitations of their position. Unlike traditional shareholders, SAFE holders do not have the following:
- voting rights;
- right to attend shareholder meetings; and
- right to appoint directors.
These investors are essentially in a holding pattern until the SAFE converts to equity.
Key Takeaways
Timing is critical. Consider when you expect your next priced round and how it aligns with your company’s valuation trajectory. This foresight helps in setting appropriate valuation caps and discount rates. Be cautious not to set a valuation cap too low or a discount rate too high if you are planning to raise funds in the near future.
Remember that SAFE investors are not yet shareholders. However, VCs sometimes request these rights. Please seek legal advice before granting special rights to SAFE holders.
Avoid stacking multiple SAFE rounds, especially when the terms vary. This can create complications for future investors and legal teams, potentially hindering your company’s ability to secure additional funding. Strive for consistency in your SAFE terms to maintain clarity and simplify future equity conversions.
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Frequently Asked Questions
No. SAFE investors do not receive shares upon investment. They only receive shares later, usually when the company completes a qualifying priced funding round, and the SAFE converts into equity.
Yes. While SAFE holders do not automatically have voting or board rights, some Australian VCs may request these protections. Any such rights must be agreed separately, usually in a side letter, and should be carefully negotiated.
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