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6 September 202214 minute read

Most frequently asked questions about SAFEs

As we set out in our article, Demystifying Safes: The Good, The Bad, and the Ugly, SAFEs (or a Simple Agreement for Future Equity) can be a useful, company-friendly tool for an efficient early stage raise. The acronym SAFE, however, does not quite portray the many complexities associated with its use. In this supplementary article, we set out some of the more frequently asked questions from founders, investors, and the curious public, in an effort to shed more light on the agreement in practice.

What does “Post Money” refer to?

The current form of SAFE offered by YCombinator (YC) is labelled as a “Post Money SAFE”. ‎This refers to the Valuation Cap being based on ownership after all money from the SAFE round ‎has been accounted for, but before the new money in a future priced equity round is accounted ‎for. It is also before the adoption of any new option pool as a part of the priced round. SAFEs ‎were always “pre” equity financing round (and still are), but in earlier versions of the SAFE, YC ‎offered a “pre-money” SAFE, which really just expressed another way of explaining the valuation. ‎A company raising $1 million at a $10 million pre-money valuation was the same as a company ‎raising $1 million at an $11 million post-money valuation. However, the pre-money SAFE left a lot ‎of uncertainty as to the relative position that a SAFE holder may have in the company, as a ‎founder could continue to raise on that same valuation, adding additional convertible securities ‎on top of the same base valuation. To be reliable, the “pre-money” practice relied on a founder ‎knowing how much they were able to raise in a SAFE round, which was often very hard to ‎pinpoint in advance. Often, this resulted in unanticipated dilution caused by each SAFE, so the ‎new approach is to use a Post Money (again, post SAFE money but always pre- priced round ‎money) to allow both founders and investors understand how much of the company they have ‎given up or purchased. ‎

What is a Valuation Cap?

A valuation cap is the ceiling price at which a SAFE converts upon a conversion event, which ‎provides a calculated floor for an investor’s equity stake in the company. More specifically, once ‎a valuation cap is agreed to, the investor will receive shares priced at the lower of the agreed-‎upon valuation cap and the valuation agreed-upon in the later priced round. This is an important ‎number for investors because it provides some certainty regarding where they may land in terms ‎of relative share ownership. For example, if a SAFE holder has a SAFE with an agreed valuation ‎cap of $5 million, in the event the company is valued at $10 million in the Series A, the SAFE ‎holder will be rewarded for their early investment by receiving A round shares at the same price ‎as if the company were valued at $5 million (so, twice as many shares as they would have had ‎for the same amount in the A round). If the value of the SAFE was $1 million, the Post Money ‎Valuation Cap of $5 million means that the investor will hold at least 20% of the company prior to ‎the equity financing event.‎ The application of a Valuation Cap on a conversion is set out in our previous article.

What is a Discount/Discount Rate?

When a Discount is agreed to, the investor will receive that amount off the share price of the ‎preferred shares issued on a conversion event (e.g. a 15% discount on the share price). The ‎SAFE refers to a Discount Rate, which is the amount actually payable once the Discount is ‎applied (e.g. the investor pays 85% of the share price in the equity financing).. A typical ‎Discount is 10 to 20%, which is the same as a Discount Rate at 90 to 80%. While these terms are ‎really just two ways of saying the same thing, it’s important to recognize the distinction as the ‎mechanics in the SAFE are built around the Discount Rate, so you would not want to agree to a ‎Discount of 20%, but record it as a Discount Rate of 20%, or you would be quadrupling the ‎intended discount. The application of a discount or discount rate on the conversion share price is set out in our previous article.

Why doesn’t YC offer the Valuation Cap and Discount version of the SAFE anymore?

YC used to provide a version of the SAFE which contained both a Valuation Cap and a Discount. In this version, the investor would receive whichever one calculation put them in a better position on conversion. YC hasn’t expressly rejected this SAFE with both options included, but it has removed this version from its main page of SAFEs. Generally, we have seen this version fall out of popular use, in part due to confusion that multiple calculations created on conversion, but also because the switch to the Post Money Valuation Cap gave more certainty to investors as to their position, so they were not required to take the “most favourable calculation” route. Interestingly, the MFN (Most Favoured Nations) version of the SAFE does provide an investor-friendly alternative to elect to convert its terms in the event that a company issues a later SAFE with more favourable terms.

What are the alternatives to a SAFE?

SAFEs have become popular and found wide-spread adoption over the past decade, but convertible bridge financing as a broader stepping stone has been a stage of fundraising for a much longer time. Convertible Notes are the most popular alternative to a SAFE (and the original model that SAFEs were intended to streamline). Much like YC created the SAFE as its own solution, other organizations have created various other funding instruments, such as 500 Startups’ KISS (Keep It Simple Security), the LEAF (Lean Equity Alternative Financing), among others, as well as other organizations’ versions of the SAFE.

What is different about a Convertible Note or a SAFE?

A convertible note is at its core a debt instrument, and as such has a few more investor protections, including interest and an option to require the note be secured. In terms of documentation, a convertible note may be a stand alone document or be accompanied by a note purchase agreement, which will contain representations and warranties and look more like a traditional purchase agreement.

When would a SAFE be preferable to a Convertible Note?

A SAFE is more preferable when there are no additional terms to be negotiated and the goal is efficiency of the transaction. Presumably in this case, there would be a larger number of smaller investors without specific terms required or negotiated outside the alternatives available under the various SAFE versions. Unlike a convertible note, using a standard SAFE with investors who have previously used SAFEs does mean there is an instant familiarity and (hopefully) understanding of the instrument, which is where the efficiency really comes into play. This is often not the case for convertible notes which can come in a multitude of different forms, albeit with lots of commonality at the heart of its terms. Both the SAFE and the convertible note can be used as short-term or long-term bridge financings in advance of a larger financing.

Can’t we just issue common or preferred shares?

Absolutely. There are many ways to raise capital through equity. Generally, a SAFE is beneficial for a company where investors want a lift on their shares negotiated later in the priced round in exchange for the early investment (ie., common shares may not be worthwhile for them), but the company is too early stage to come up with a worthwhile valuation. When issuing common or preferred shares, you will also need to consider having appropriate shareholder, voting, voting trust or other such agreements in place, and in the case of preferred shares, negotiating the actual share rights, all of which adds to time and cost of the financing, whereas these will come into place only on conversion of the SAFE in the event of an Equity Financing.

Can we issue SAFEs on different terms?

Yes, but use caution. While it may make sense to have a SAFE outstanding in one year at a valuation cap of $30 million, and a SAFE the following year at a valuation cap of $50 million, it does not make sense to offer these for sale at the same time. The reason being that the Company has been valued differently in each and this will lead to a very confusing calculation when it comes time to convert the SAFEs into preferred shares on the priced round and potentially over diluting the founders’ shares. Similarly, having some SAFEs with valuation caps, and others with discounts (particularly different discounts), creates complexity when converting. In the event that SAFEs with different terms convert together, the company will need to issue multiple subseries of preferred shares, and corporate law imposes limitations on the manner in which shares within the same class may differ. While solutions are possible, it’s important to understand what level of complexity you’re introducing into the process before doing so.

Do typical securities laws apply?

Yes, we would generally consider a SAFE to be a security, as with any convertible note, even prior to it converting to a preferred share. This means that the issuer is still bound to comply with applicable securities laws in the same way it would be when issuing any other share. Often SAFE holders may fall under a prospectus exemption category, such as an accredited investor or as family, a friend, or business associate, but issuers should consult with their legal counsel for jurisdiction and company specific considerations. Filings may need to be made if the issuer is no longer a private issuer or the recipients do not fall under certain exemptions.

Do investors complete diligence?

It depends on the size of the investment. Smaller investors who purchase a SAFE for, say, $20,000-$100,000 are unlikely to do much legal diligence, and the issuer may not have the capacity to support their full diligence attempts. Larger investments (say $2,000,000 and up) using a SAFE as a vehicle may warrant a bit more diligence from the investor. This does not mean that any business-specific representations or disclosure are, or should be, included in the SAFE in the same way they would be included in a more typical purchase agreement — it simply reflects the reality that investors are still buying a relatively illiquid security and may be investing at a level that warrants limited and situation specific diligence.

What if we want additional terms?

The beauty of a SAFE is in its familiarity when used as-is. Should the Company wish to grant additional rights to a larger investor in a SAFE financing (for example, pro rata rights in the round after financing, or certain financial information rights), the Company and SAFE holder may enter into a side letter to account for these agreements. No changes or revisions should be made to the body of the SAFE itself to account for these side agreements. Although there are some limited situations where a side letter may be a pre-requisite of an investor agreeing to invest through a SAFE (e.g. some government funded investors have reporting requirements that will need to make it into a shareholders agreement following an equity raise), having many side letters or conflicting rights outstanding can lead to an administratively burdensome operation at best, and conflicting agreements that will need to be renegotiated in the context of a shareholders agreement at worst. If investors are generally pushing for side letters or additional negotiated terms, it may mean that a SAFE is not the right instrument for the deal.

What else do we need to do?

The board will approve the issuance of the SAFEs and any side letters before “closing” on any of them. We recommend that funds are received before countersigning the SAFEs and “closing” on any of them. The company may also need to amend its articles, share rights or shareholder agreements to account for the rights SAFE holders will receive, or in connection with the liquidation preferences.

What happens if the company does not do a priced equity round?

The SAFE could sit on the books of the company for a long while (in fact, forever) if it neither completes a priced round nor issues preferred shares at a fixed valuation. This means that the investors money could be tied up for a very long time without any right to demand conversion or repayment; however, this is not much different than an investment for shares in a private company for which there is not much liquidity (if any), or ability to demand repurchase.

Is there any way that an investor can get any money back?

Yes, on a dissolution or liquidation of the business, a SAFE holder would be eligible to receive up to their investment amount back. This right will sit behind payment on outstanding unsecured indebtedness or creditor claims and in line with other standard preferred shares. Some founders may choose to terminate a SAFE if they have been able to “fail early” or wish to move on to a new venture. In this instance, the company may enter into a SAFE termination agreement and return the funds back to the investor, often hoping the investor will follow on to their next venture.

What if the Company is acquired?

If the Company goes through a change of control (is acquired) or goes public, then the SAFE holder is entitled to receive an amount of the proceeds of the sale or liquidity event equal to the greater of: 1) a return of its investment amount; and 2) the proceeds it would have been entitled to had its SAFE converted to preferred shares under the terms of the applicable SAFE.

How does an investor receive the Shares on an Equity Financing?

The SAFE will automatically convert to Shares in the same class as the preferred share investor(s). The SAFE holders will receive a share purchase agreement setting out certain limited representations with respect to the shares and will receive the conversion shares on closing of the Equity Financing.

How do we deal with different liquidation preferences?

Investors in a priced round will typically negotiate a liquidation preference on their shares. The SAFE holders may not be entitled to the same liquidation preference (or conversion price or dividend rate) based on the fact that they are receiving the shares at a different price based on the conversion mechanics of their SAFE. In that event, the company would create a sub-series of the same class of preferred shares. A SAFE holder would then receive the same Class of preferred shares, but the sub-series would have a different value on liquidation.

Can we change the SAFE?

Yes, on agreement with the investor. Like any written agreement, the parties may generally agree in writing to amend, amend and restate, or terminate the agreement altogether. We do caution careful consideration of the changes you may be making to a SAFE, and in line with the recommendations in this FAQ to keep things as close to the form of SAFE as possible.

YC has updated their SAFE to a Post Money SAFE. What do we do if we have Pre Money SAFEs outstanding?

You could either deal with the conversion mechanics when needed down the road, or could discuss amending the original Pre Money SAFE to a Post Money SAFE on equivalent terms.


This article provides only general information about legal issues and developments, and is not intended to provide specific legal advice. Please see our disclaimer for more details.