SAFE Investment Rounds
In 2013, Y Combinator developed and introduced the SAFE investment round for startups. A simple agreement for future equity (SAFE)is now the go-to option for 'almost all YC startups and countless non-YC startups as the main instrument for early-stage fundraising'. As a result of startups looking to raise smaller amounts in advance of a priced round of financing, like a Series A Preferred Stock round, the SAFE allowed for a 'simple and fast way to get that first money into the company' with the idea that SAFE holders were just early investors. It is important to note that 'SAFE notes require C-Corp status because the investment is noted on a capitalization table just like stock options'. While Y Combinator is still the leader is SAFEs, 'other players in the startup finance ecosystem have created form documents similar to the SAFE but using different names'. Examples of these include a convertible security proposed by a partner at the law firm of Wilson Sonsini Goodrich & Rosati and the 'Keep it Simple Security (KISS) created by 500 Startups, another startup accelerator'.
- Compared to lengthy and complicated convertible notes (a common alternative), a SAFE round offers investors 'a 5-page document that was created to streamline the seed investment process'.
- SAFE investments do not 'carry an interest rate and don’t have a maturity date'.
- SAFEs require little negotiation more than discussions regarding valuation caps.
- With no predefined terms or maturity dates, SAFEs give 'the startup total freedom with no specific destination or expectation'.
- While a convertible note provides options for stock or future financing, a SAFE round 'only allows for a conversion into the next round of financing'.
- SAFE investments can 'convert when any amount of equity investment' is raised.
- A SAFE investment provides 'simplicity, but it doesn’t give the control to the entrepreneur'.
- Another important factor is that 'raising common stock doesn’t trigger a conversion for a SAFE investor, so entrepreneurs in need of some extra cash could do a "friends and family round" and avoid the conversion trigger if there is a need to bridge'.
- Data from the SEC states, 'if a SAFE specifically triggers upon an offering of preferred stock, but the company subsequently raises money by instead selling more SAFEs, common stock or convertible notes, or by getting a conventional bank loan, then the SAFE will not convert despite the company having raised more capital'.
- It is possible, depending on a company's positioning, that SAFEs can be issued 'without a valuation cap', though it can be tricky. Andrew Krowne, of Dolby Family Ventures, states that, 'We have observed that many founders don’t do the basic dilution math associated with what happens to their cap table (specifically their personal ownership stakes) when these notes actually convert into equity. By kicking the valuation can down the road, often multiple times, entrepreneurs end up owning less of their company’s equity than they thought they did. And when an equity round is inevitably priced, entrepreneurs don’t like the founder dilution numbers at all'.
- 'It's debatable as to whether a SAFE would trigger the need for a fair (409a) valuation to formalize common stock value. Avoiding this means potentially avoiding paying for the professional services involved with getting a 409a valuation.'
- 'SAFEs can include a discount, a valuation cap, both, or neither, though, it is not common for either to be absent, as that would discourage investors'.
- Both convertible notes and SAFEs offer 'similar payout mechanism(s) in the event of a change in control (acquisition/IPO) before a conversion can occur'.
- SAFEs are designed to 'give the investor the choice of a 1x payout or conversion into equity at the cap amount to participate in the buyout'.
- SAFEs are not debt instruments, they are defined as warrants and do not carry an interest rate.
- As 'most entrepreneurs don’t need another expense', a SAFE note carries an advantage over a convertible note.
- There could be an 'instance in which after the SAFE note is signed and a valuation cap discount is arranged', allowing another investor to offer 'a larger cap and a request that the SAFEs convert to a higher cap'.
- As SAFEs are not debt instruments, 'there is a chance they will never convert to equity and that repayment is not required'.
- Incorporation is a requirement for SAFEs, thus 'a company will have go through the incorporation process before being able to issue SAFE notes, which may require the services of an attorney'.
- From an investor standpoint, the SEC cautions that because 'a SAFE is an agreement to provide you a future equity stake based on the amount you invested if—and only if—a triggering event occurs. SAFEs do not represent a current equity stake in the company in which you are investing. Instead, the terms of the SAFE have to be met in order for you to receive your equity stake'.