SAFE’s (Simple Agreement for Future Equity) are a financing tool used by startup companies to raise capital from investors early on and without great encumbrances. Companies will create SAFE’s with investors prior to a formal round of financing. This instrument allows the investor to provide the company with a purchase amount in order to receive company equity in the future upon the occurrence of some specified event. This specified event is decided amongst the parties. The agreement specifies the terms and conditions under which the investment will convert into equity, but does not specify the number of shares or the conversion price that will be received by the investor. SAFE’s are intended to be beneficial to both companies and investors because of its flexibility and relative simplicity. Although a SAFE is effectively a contract between a corporation and an investor, it is important to always consider and follow the registration regulations.
What is the Difference Between a SAFE and a Convertible Note?
Convertible notes are tools for early investments with future equity in the start-up but are also debt instruments. If the business uses this type of instrument to secure early financing, they are assuming debt by having to repay the principal and pay interest. This assumption of debt could discourage other investors during the formal round of financing. A SAFE is not a debt instrument. SAFE’s do not require repayment from the business to the safeholder and they do not acquire interest. SAFE’s are less formal and quicker for both parties. However, SAFE’s have their limitations and sometimes the formality of a convertible note is appropriate. Both a convertible note and a SAFE are tools for investors to obtain future ownership in a startup company, but they differ in key ways. Make sure to explore both options before entering into either agreement.
What Are the Main Components of a SAFE Agreement?
A SAFE agreement can include: (1) conversion trigger, which is an event that will trigger the conversion of the SAFE into equity, such as a future equity financing round or the attainment of a specific milestone; (2) conversion price, which is the price per share that the SAFE will convert into at the conversion trigger (usually determined based on the valuation of the company at the time of the trigger event); (3) valuation cap, which is a predetermined maximum valuation of the company that the SAFE will convert into equity at, regardless of the actual valuation of the company at the time of the conversion trigger; (4) discount rate, which is a percentage by which the conversion price of the SAFE will be reduced when compared to the price per share received by investors in the next equity financing round; (5) expiration date, which is the date by which the SAFE must convert into equity or become void; (6) anti-dilution provision, which are provisions that are meant to protect the investor’s interest in the event of subsequent equity financings at a lower price per share; and (7) rights and obligations of the parties, which includes the rights and obligations of the company and the investor, including the payment and repayment of the SAFE, and the timing and conditions of conversion.
There are three variables that must be specified in the SAFE: the amount of the investment, a valuation cap, and a specified triggering event. The parties will negotiate these matters.
The specific terms and conditions will vary depending on the company, the investor, and the jurisdiction. Similar to any other contract, a SAFE can be amended by the company and investor.
Do I Have to Register a SAFE Agreement With the Government?
Normally, a SAFE agreement does not need to be registered with the government. Unlike traditional equity offerings, SAFEs do not have to be registered with the Securities and Exchange Commission (SEC) or any other regulatory agency. This makes them a more cost-effective and simpler way for startup companies to raise capital, as they do not have to comply with the same regulatory requirements as traditional security offerings.
Are There any Monetary Limits to SAFE Agreements?
There is no specific monetary limit to SAFE agreements. The amount of capital that can be raised through a SAFE is determined by the company and the investors involved in the agreement. Companies can raise any amount of capital through a SAFE, as long as they find investors who are willing to provide the funds. However, it is important to note that SAFEs are typically used by startup companies as well as early-stage companies that are looking to raise smaller amounts of capital. Larger, more established, companies may opt for a traditional equity financing round instead.
Who Are the Parties to a SAFE Agreement?
The parties to a SAFE agreement are the startup company and the investor. The startup company raises capital from the investor in exchange for a promise to issue equity in the future, typically upon the attainment of a specific milestone or the completion of a future equity financing round. The investor provides capital to the startup in exchange for the right to convert their investment into equity at a later date. Both parties are bound by the terms and conditions outlined in the SAFE agreement, which outlines the rights and obligations of both parties, including the conversion trigger, conversion price, and other key terms.
How Long Do SAFE Agreements Last?
The duration of a SAFE agreement can vary, but it typically has an expiration date, beyond which the agreement becomes void. The expiration date is specified in the agreement and is the latest date by which the SAFE must convert into equity. If the conversion trigger has not occurred by the expiration date, the investor may not be entitled to receive any equity and the invested capital may not be returned. The length of a SAFE agreement can range from a few months to several years, depending on the specifics of the agreement and the terms agreed upon by the company and the investor.
What Happens After the Expiration of a SAFE Agreement?
Once a SAFE agreement has expired, there are several potential outcomes, depending on the terms and conditions outlined in the agreement: (1) conversion into equity; (2) extension of the agreement; and (3) forfeiture of the investment.
If the conversion trigger specified in the agreement has occurred prior to the expiration date, the SAFE will typically convert into equity, and the investor will receive the specified number of shares based on the conversion price and any discount or valuation cap outlined in the agreement. In some cases, the parties may agree to extend the expiration date of the SAFE agreement if the conversion trigger has not occurred. If the conversion trigger has not occurred and the parties do not agree to extend the agreement, the SAFE may become void and the investor may forfeit their investment.
It is important to note that the specific outcome of a SAFE agreement after its expiration will depend on the terms and conditions outlined in the agreement and any amendments made to the agreement by the parties. It is always recommended to consult with a qualified attorney before entering into any type of investment agreement to ensure that all rights and obligations of the parties are clearly understood.
What Due Diligence Should Be Done Prior to Executing a SAFE Agreement?
Prior to executing a SAFE agreement, both the startup company and the investor should engage in due diligence to assess the potential risks and benefits of the agreement. The due diligence process can include the following steps: (1) review of the business plan and financial projections; (2) review of the company’s legal and regulatory compliance; (3) review of the company’s existing funding and equity structure; (4) review of the company’s management team and key employees; and (5) review of the SAFE agreement.
The investor should review the company’s business plan and financial projections to gain a better understanding of the company’s business model, market opportunity, and potential for growth. The investor should also ensure that the company has all necessary licenses and permits and is in compliance with all applicable laws and regulations. The investor should understand the company’s existing funding and equity structure, including any outstanding debts, obligations, or previous investments. The investor should further assess the experience, qualifications, and track record of the company’s management team and key employees. Finally, both the company and the investor should carefully review the terms and conditions of the SAFE agreement, including the conversion trigger, conversion price, expiration date, and any other key terms, to ensure that all parties understand their rights and obligations.
This due diligence process can help both the company and the investor make informed decisions about the SAFE agreement and can help mitigate potential risks and uncertainties.
