What it means
Early-stage start-ups often find it hard to agree on a value for the company, because there is little revenue to measure. A SAFE postpones that decision.
The investor pays now and the shares are issued later, when a larger investor sets a price in a funding round. The start-up accelerator Y Combinator introduced the SAFE in the early 2010s, and it is now widely used in many countries.
Its popularity comes from its short length, standard terms and low legal cost. A SAFE usually contains two features that decide how many shares the investor receives.
A valuation cap sets the highest company value at which the SAFE converts, and a discount gives the investor a lower price than the new investors pay. The investor normally receives the better of the two.
The SAFE converts into shares at the next priced round, and it may also convert on a sale of the company or a stock market listing. If the company fails before any of these events, the investor may receive little or nothing, depending on the terms.
Founders must understand dilution. Several SAFEs signed at different caps can add up to a large share of the company, and the founders' ownership falls on conversion.
A table showing ownership before and after the next round is essential. SAFEs come in versions.
In the older pre-money version, the cap applies before the SAFE money is counted, while in the post-money version the cap includes the SAFE money, which makes each investor's percentage easier to work out. Founders and investors should check which form is in use.
In practice
Real-world examples
Example 1
A two-person software start-up raises $250,000 from three angel investors using SAFEs with a $4,000,000 cap. The founders avoid legal costs of a full share sale. The SAFEs convert when the company raises its first priced round a year later.
Example 2
An investor puts $50,000 into a SAFE with a discount of 15% and no cap. The company later raises money at $2.00 a share. The investor converts at 2.00 x 0.85 = $1.70 a share and receives 50,000 / 1.70 = about 29,412 shares.
Example 3
A start-up that signed SAFEs for $600,000 in total is acquired before it raises a priced round. The SAFE terms say the investors can choose between getting their money back and converting to shares at the cap. The investors take the higher value.
Think of it
Buying a voucher for a bakery that is still under construction. You pay for your pastries in advance at a guaranteed future discount, and once the bakery opens, you exchange your voucher for actual food items.
Formula
Calculation
Conversion price = The lower of (Cap price) and (Round price x (1 - Discount))
Cap price = Valuation cap / Company capitalisation (shares)
Suppose an investor puts $100,000 into a SAFE with a $5,000,000 valuation cap and a 20% discount. The company has 10,000,000 shares in its capitalisation, as defined in the SAFE, so the cap price is 5,000,000 / 10,000,000 = $0.50. The next round is priced at $1.00 a share, so the discount price is 1.00 x (1 - 0.20) = $0.80. The lower price is $0.50, so the investor receives 100,000 / 0.50 = 200,000 shares. Without the cap, the discount alone would have given 100,000 / 0.80 = 125,000 shares.Case study
Seen in the real world
Lumen Health is an illustrative, fictional health-technology start-up that raised $400,000 through SAFEs at a $4,000,000 cap. Over the next year, a second batch of SAFEs at an $8,000,000 cap brought in another $400,000.
When the company raised a priced round, the founders discovered that the SAFEs converted into roughly 15% of the company on top of the new investors' share. They had been so focused on raising the money that they had not tracked the dilution.
The founders now keep a cap table (a record of who owns what) that shows how every SAFE would convert at different round sizes. In this illustrative story, they also negotiated the next round with a clear picture of their ownership.
Watch out
Common mistakes
- Treating a SAFE as a loan, when it has no interest or repayment date and converts into shares.
- Ignoring the combined effect of several SAFEs, which can take a larger share of the company than expected.
- Assuming that all SAFEs have the same terms, when the cap, the discount and the pre-money or post-money form can differ.
Questions
People also ask
What does SAFE stand for?
It stands for Simple Agreement for Future Equity.
What is the difference between a SAFE and a convertible note?
A convertible note is debt that usually has interest and a maturity date, while a SAFE is not debt and has neither.
What happens to a SAFE if the company is sold?
The terms normally let the investor take either their money back or the value of the shares they would have received, whichever is higher, but the wording of each SAFE decides.