A “SAFE,” or “Simple Agreement for Future Equity,” is a type of fundraising agreement commonly used by startups that attempts to act as convertible equity. SAFEs were created by startup accelerator Y Combinator in 2013 and have since gained increasing popularity among startups looking to raise money without having to issue traditional notes or preferred stock. In theory, SAFEs act as a right to purchase equity in a company in the future, without being considered debt or equity in the meantime.
As noted above, SAFEs are most commonly used by startups, especially those in the technology space. However, other new businesses or enterprises may also look to use SAFEs when raising funds.
For startups and investors, one of the main benefits of SAFEs is that they may be easily and quickly negotiated and executed. Additionally, for startups, SAFEs can be a quick and easy way to raise funds without having to issue traditional convertible notes, which carry with them financial burdens in the form of interest rates, and default risks in the form of set maturity dates. SAFEs may also offer tax advantages to the parties in certain situations as well.
Because SAFEs are designed to act as a future contract right to receive equity upon the occurrence of certain events, but do not contain a maturity date, one the biggest downsides to using SAFEs, at least for investors, is the risk that the SAFE may never convert, in which case an investor may lose their entire investment without ever receiving equity. Additionally, even where a SAFE does convert to equity, SAFE investors may not receive any voting rights with that equity, a benefit that is commonly provided to early investors who invest using other traditional instruments.
For startups seeking funding, investors unfamiliar with SAFEs may be unwilling to use the instruments. Lastly, depending on the type of SAFE used, both investors and founding members of a startup may risk having their interest be diluted in the event a raise round turns out to be larger than expected.
For parties looking to invest, or startups seeking to raise funds, without using SAFEs, using convertible notes or revenue sharing agreements, or issuing traditional common or preferred stock may serve as prudent, and more proven investment methods. In addition to generally allowing for greater customization than SAFEs, such alternative options have the benefit of a long history of usage among companies and investors, lending to greater legal certainty in how courts will interpret their use, and familiarity among investors who may otherwise be hesitant to use the relatively new SAFE.
Where parties do decide to use SAFEs, special care should be paid to the terms of the SAFE, notwithstanding some parties’ argument that the only terms of a SAFE that need to be negotiated are valuation caps and discount rates. As with any other legal agreement, terms are negotiable and, in all cases, should be carefully tailored and reviewed to meet the understanding and intent of the parties to the transaction. For SAFEs, in addition to the valuation cap and other figures used in the SAFE, special attention should be paid to the “Events” provisions, including those governing equity events, liquidation events, and dissolution events. Parties should also carefully review the representation and warranties sections, to ensure the claims they are making to the other party are true and correct.
