When is a SAFE not a SAFE?
Welcome Innovators and Founders!
Just recently, we’ve been hearing quite a lot about SAFE agreements - so we thought we’d just clarify a couple of things as some agreements that are called SAFE agreements - aren’t.
What is a SAFE?
A SAFE is a Simple Agreement for Future Equity. A “genuine” SAFE is the most founder friendly in that an investor gives funds to a company, does not receive shares immediately but will receive shares in the future (when there is a further capital raise, the company is sold etc). The investor return is generated because the future shares are issued at a discount to the future round price. The investor has no formal rights, control etc until shares are issued.
SAFE key advantages for a founder:
There is no need to have a valuation discussion - the future round determines the price at which the SAFE amount converts to equity.
Cash up front - without strings! A “pure” SAFE means that the investor gets no shares until the next priced round - so no shareholder rights, no shareholder agreement etc.
Not a loan. SAFE can’t be repaid in cash, and are explicitly not loans (which is very good for the Founder)
Generally, cheaper to execute as a SAFE is a simpler legal document.
SAFE key disadvantages for an investor:
There’s no protection for the funds invested. A SAFE isn’t a loan and it’s not equity so at best this is an unsecured creditor if everything goes really badly.
There’s no control, monitoring or influence : Funds invested up front, but no mechanism to get ongoing reports on progress, prevent company killing moves, comment/stop sale, takeover, non-formal equity rounds etc.
The valuation is determined at a future date. So, if things go really well, the next round price can be higher than what the investor expected and the investor ends up with a smaller equity holding than they expected/wanted, in percentage of equity terms.
There’s no specified conversion date - it’s just when the next round occurs, or company sold. So, if the business becomes self funding - the SAFE potentially never converts.
What these disadvantages mean is that investors will often try and reduce the impact by inserting terms to mitigate them.
When is a SAFE not a SAFE?
For a Founder, a SAFE is not a SAFE when it isn’t simple any more. For us, you aren’t dealing with a SAFE if either of the below exist.
There is a valuation : This can be either a “base” price (usually associated with a fixed future conversion date) or a “valuation cap”. The inclusion of either of these means that you, as the Founder, needs to determine what your company is worth today. In particular, a valuation cap needs to be VERY CLOSELY looked at, because these can have very significant impacts on the founder equity percentage if the company value explodes.
The investor gets rights (other than regular, reasonable, reporting). Having to clarify what those rights are (is it a veto? a consultation? what does consultation actually mean?) and how to deal with them if there is a disagreement is not simple.
The SAFE has a cash repayment option. A cash repayment option basically puts this squarely back into convertible loan territory.
What should a Founder do if it’s not a SAFE?
The answer is simple : Get professional advice. Just like you would if the offer wasn’t called a SAFE.
As we described above, a “genuine” SAFE has a number of quite significant investor disadvantages. It is perfectly reasonable for an investor to want to address some of these disadvantages. It does NOT automatically mean that the investor is trying to rip you off, or steal your company or idea.
If you’re not dealing with a SAFE, even if it is called a SAFE, it’s not a good idea to just hope for the best. Discuss with the investor what they are trying to achieve with the additional clauses. Then get professional advice (oh, and AI isn’t the right answer here).
Until next time!