What the heck is a SAFE (Simple Agreement for Future Equity)?
A SAFE is a popular method to invest in super early-stage companies. At its core, it’s an agreement – an investor puts money into a startup today and both parties agree that, in the future, that money can convert into stock.
The SAFE was created by (two badass women on) the Y Combinator team back in 2013.
What triggers this conversion to stock?
This one, magic moment of conversion happens when the startup starts its next official round of fundraising. For most Wefunder startups, this next round is “Series A” because crowdfunding on our site is their “seed round.”
This Series A round usually involves selling stock to venture capitalists (VCs). VCs are professional investors that invest millions of other people’s money into startups.
Does this mean *money in the bank* for a Wefunder investor?
In terms of seeing a return, odds are high that a successful startup will go through several rounds of raising from VCs and years will pass before a Wefunder investor sees *money in the bank.* Investing in startups means (hopefully) playing the long game and using SAFEs to do so is no exception.
What are the most key terms in this agreement?
The most common type of SAFE you’ll find on Wefunder has one really key term: the Valuation Cap– an investor-favorable feature. The cap favors investors because it puts a maximum on the SAFE investor’s eventual price per share– the lower the cap, the lower the price per share, the more shares an investor expects to own later.
Let's say you invest in a startup using a SAFE with a $5 million cap. If the Series A investors decide that the company is worth $50 million dollars and agree to pay $1/share, then your SAFE will convert as if the price had actually been $5 million. By dividing $50 million by $5 million we get an effective price $.10/share. That means that you will get 10x as many shares as the Series A investors for the same price. Essentially, a SAFE investor hopes a startup exceeds this cap in their next round so that their own investment converts at a lower price and they end up owning more shares for having invested early.
Sometimes, you’ll see a SAFE with a Discount Rate (usually 10-20%). This means investors’ money will convert to shares at a discounted rate and, like the cap, sets up very early investors to get more shares upon conversion than investors in later rounds.
Sometimes a SAFE will only have a discount & sometimes it’ll have a discount and a cap. In contracts with both, only one is ever applied. If the company raises more than the cap in their Series A, the cap will be applied. If they raise less, the discount is applied. In these instances, the discount acts like a safety net of sorts.
Most Favored Nation (MFN)
The last type of SAFE you’ll find on Wefunder is an uncapped SAFE with a Most Favored Nation (MFN) clause. As the “uncapped” part suggests, this SAFE does not include a cap nor a discount. As such, this type of SAFE is most common among the earliest stage startups that don’t want to set a cap yet and the earliest investors who want to be as flexible as possible to get in on the action.
Plus, the MFN clause of this type of SAFE offers the earliest SAFE investors a bit of a safety net. This clause states that, if another SAFE investor later negotiates either a cap or a discount, then the earlier investor can choose to adopt the terms of that agreement.
Why do founders like SAFEs?
Early-stage startups like SAFEs for 3 main reasons:
- SAFEs are quick and easy compared to selling actual stock. Starting to sell stock can cost up to $50k in legal fees– it’s also a massive headache and time suck for founders. By issuing SAFEs, they’re able to raise some money, focus their energy and money on their enterprise, and wait until VCs shell out the money for contract lawyers later on.
- SAFEs don’t require early-stage startup founders to take on the difficult task of estimating the value of their company. The valuation cap in the SAFE is not meant to be a true valuation– it’s in the contract to ensure early investors are later rewarded for taking a risk on a young company.
- SAFEs are not loans. This is critical because another type of convertible security that early-stage startups use, a Convertible Promissory Note (C-Note), is a loan. This means that the money accrues interest, there’s a maturity date, and, of course, a legal obligation that the startup pays the investor back (though this rarely happens if a venture goes bankrupt).
Why do investors like SAFEs?
SAFE investors are able to take up terms that VCs spend a ton of dough on negotiating later for their own stock. The stock that VCs buy is deluxe (“preferred”) stock and there’s a whole sheet of terms that they negotiate before buying it.
Basically, SAFE investors get to ride on the coattails of VCs doing what they do best– except they get to enjoy these terms at a lower price per share, too.
Is there a chance my SAFE never converts?
Sometimes, the next thing to happen after crowdfunding on Wefunder is that a startup is bought by a larger company– startup land refers to this as an “early exit.” If this happens, a SAFE investor has 2 choices: 1) get their money back, or 2) get the amount payable to them if the SAFE converts under its terms.
There’s also the very real possibility that the startup dissolves or goes bankrupt in which case SAFE investors are rarely paid.
Lastly, it's possible that the startup never raises another official round of fundraising. That said, if a startup doesn’t at least intend to do so after raising on our site, we’ll recommend they don’t offer SAFEs to investors. For example, we recommend other types of contracts for lifestyle businesses that don’t really need VC money in order to become successful.
Are SAFEs riskier than other types of contracts?
Legally speaking, SAFEs are riskier than C-notes because they’re not loans. Practically speaking, though, investors who use C-notes are almost never repaid if the company goes south. Since these contracts are extremely similar beyond this element, they’re comparable in terms of investor risk.
SAFEs are riskier than directly buying Preferred Stock because they’re the promise of stock rather than stock itself. But, of course, a SAFE holder also has a chance of seeing a much higher return because of the risk they’re taking.
SAFEs are also riskier than simple loans or revenue share contracts but are generally used for different types of startups anyway.
So can a Wefunder investor figure out the number of shares they’ll own based off of their initial investment and the valuation cap?
Unfortunately, investors can't really determine how many shares the SAFE will convert into until the actual conversion event (ie., official or “priced” round) happens. This is due to factors such as the number of shares outstanding and the size of the employee option pool.