*SAFE (simple agreement for future equity)
This is a standard agreement between investors and companies. It is a guarantee for the issuance of shares in a priced round and therefore is basically a future contract. Founders sign the SAFE with investors, receive the money and the investor then gets shares in the future.
Put in simple terms, SAFE is simply a Convertible Note with no guarantees in case of default, no interest and no due date.
SAFE works as follows: an investor provides the company with cash, and when a startup enters a new round of investment, SAFE is automatically converted into shares of the company, of the same class and type, and having similar rights, to the shares issued at the financing.
SAFE, unlike the Convertible Note, is a capital note, and not a debt instrument, and therefore it has no maturity or interest, and these are the main advantages of SAFE for startups.
SAFE contains several general conditions that govern how the conversion into shares of the company takes place. The main four conditions are discounts and valuation caps.
Discount
SAFE agreement may include a discount, when a SAFE investor may want to convert into shares at a discount to the subsequent round of funding. The discount usually ranges from 10 to 30%. For clarity, instead of buying shares at $1.00, the SAFE holder will have the right to buy shares at $0.70, in case of 30% discount. A common confusion in the SAFE template that is worth mentioning, relates to the definition of “Discount Rate”, which in case of a 30% effective discount would be 70%.
Valuation Cap
This is another term that can be found in a SAFE agreement. It is a different option for a SAFE investor to get a better share price than a later investor, but also to limit the investor’s exposure to high valuations and growth achieved using the SAFE investor’s and other pre-round funds. If your company raises the investment at a valuation above the “cap”, then the investor under the SAFE agreement receives a conversion at a limited valuation. Sometimes SAFE contains both a limitation and a discount. In such a scenario, the SAFE holder chooses either a cap or a discount on conversion, whichever is better for the investor.
Two additional terms that do not directly relate to conversion,
but will affect the final result for the investor:
MFN Provision
Most Favored Nation Provision occurs when an investor enjoys the best terms in an agreement given by its partner. Suppose SAFE “A” has an MFN position. If another SAFE agreement is created, let’s call it SAFE “B”, then the company is obliged to notify the investor with the SAFE “A” agreement. If the terms of the SAFE “B” agreement are better for the investor than in the SAFE “A” agreement, then the investor of the SAFE “A” agreement may request the same terms as in the SAFE “B” agreement.
Pro Rata Rights
With pro rata preemptive rights, or eligibility, investors can invest additional funds to maintain their stake in the round following the round where SAFE was converted to shares. When exercising the right, the investor pays a new price corresponding to the current round to purchase new shares, and in parallel, the investor’s SAFE is converted based on the SAFE terms.
Conclusion…
The current versions of SAFE uses the post-money valuation mechanism, post-money discount or both, that is, it determines the valuation of the company and discount received by investors, taking into account the investment according to SAFE (Purchase Amount).
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