There are several ways a startup can raise capital. Using a Simple Agreement for Future Equity (SAFE) is increasingly common for Australian startups. Using a SAFE, an investor will give your company a cash payment upfront (often called the investor’s ‘purchase amount’). In exchange, the investor receives a right to convert that amount into shares when certain pre-agreed trigger events occur. A SAFE does not include a guarantee that the investor will be repaid if a trigger event does not occur. However, it will commonly include a discount to the market value of a share when the SAFE converts. This allows the investor to receive shares at a lower price than what they are worth.

Using a SAFE is attractive for startups because it is simple and saves the company from having to issue shares to investors (and therefore negotiate a valuation) upfront. However, your SAFE will likely convert into shares at some point, so it is important to understand the:

  • consequences of a SAFE converting; and 
  • practical steps your company must take when this happens.

SAFE Investors on the Cap Table

A SAFE converts into shares at pre-agreed trigger events. These trigger events are usually:

  • a ‘qualifying round’ (where the company raises a round of equity investment through the issue of shares to investors); or
  • an ‘exit event’ (where a company sells its shares or assets, or lists on a stock exchange).

A SAFE investor does not receive shares upfront at the time they provide the purchase amount to your company. However, they will receive shares if a trigger event occurs. Therefore, it is very important to carefully consider the effect of any SAFE conversions on your company’s cap table

For example, when you are considering undertaking a qualifying round, you will need to prepare a capitalisation table that shows what the company’s share structure will look like after the qualifying round is complete. In this capitalisation table, it is important to show the:

  • new investors being issued shares as part of the qualifying round; and 
  • shares which will be issued to your SAFE investors upon conversion of their SAFEs. 

This is important because it allows you to consider the potential dilutive effect of the SAFE conversions on the existing shareholders’ shareholdings. In turn, this may affect how much of the company you are willing to part with in your qualifying round. Your new investors will also want to understand the effect of SAFE conversions. This is because the SAFE conversions will impact how much of the company they own after the qualifying round is complete.

Conversion at a Qualifying Round

If there is a qualifying round, the SAFE automatically converts into shares. Your SAFE may require you to give your SAFE investors written notice, often referred to as a ‘conversion notice’. This notice states the company’s intention to issue the SAFE investor with shares as a result of the qualifying round. The conversion notice should also set out:

  • the number of shares to be issued to that SAFE investor; and 
  • how the company calculated that number of shares.

To determine the number of shares to issue to the SAFE investor, divide the SAFE investor’s purchase amount by a certain share price. That share price is generally the share price of the qualifying round, subject to a discount for the SAFE investor. This discount allows the SAFE to convert at a lower share price. Therefore, the SAFE investor gets more shares for their money. However, if your SAFE includes a valuation cap, you could instead determine the share price by reference to the valuation cap if this results in a lower share price than the share price in the qualifying round (applying any discount).

When a SAFE converts, you will also need to determine the class of shares to issue to the SAFE investor. Where a SAFE is converting as part of a qualifying round, the company will usually need to issue to the SAFE investor the same class of shares as it issues as part of that qualifying round. 

For example, if the company is undertaking a seed round of equity investment where it issues ‘seed preference shares’, the SAFE investor would also receive ‘seed preference shares’.

Conversion at an Exit Event

A SAFE will usually require the company to:

  • immediately notify the SAFE investor when it enters into documents to give effect to an exit event; and 
  • allow the investor to choose whether they want to be repaid their original purchase amount in cash or convert their purchase amount into shares.

If the investor chooses to convert their SAFE, the company will determine the number of shares to issue to the SAFE investor by dividing their original purchase amount by a certain share price. That share price is generally the share price related to the exit event (this is typically the fair market value of an ordinary share in the company at the time of the exit event), subject to a discount for the SAFE investor. Again, however, if your SAFE includes a valuation cap, the share price used for the conversion could be determined by reference to the valuation cap if this is preferable for the SAFE investor.

For conversion at an exit event, the company will issue ordinary shares to the SAFE investor. This means that the SAFE investor will be treated like other ordinary shareholders as part of the exit event.

Issuing Shares Upon Conversion

When the SAFE converts, the company will need to undertake a number of steps in order to issue shares to the SAFE investor. 

First, the company will need to approve the issue of shares to the SAFE investor. This is usually approved through the directors passing a board resolution. Depending on the terms of your company’s shareholders agreement, you may also need to obtain shareholder consent to the issue of shares to the SAFE investor. You can often incorporate these approvals as part of the approvals for the qualifying round or exit event.

Also, your investor will need to sign the company’s shareholders agreement, or a deed of access to the shareholders agreement, if there is one.

The company will need to:

  • update its register of members to record the shares as issued;
  • give the investor a share certificate for their shares; and 
  • notify ASIC that the shares have been issued.

Key Takeaways

If you are raising capital using a SAFE, you need to consider what will happen when the SAFE converts into shares. You will need to understand: 

  • the trigger events which give rise to conversion (i.e. a qualifying round or an exit event);
  • how the number of shares to be issued to the SAFE investor will be calculated; 
  • how the company’s cap table will be affected following the conversion; and 
  • what steps the company needs to take to effect the conversion.

If you have any questions about SAFEs, or require assistance drafting or converting a SAFE, contact LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.

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