Understanding A SAFE Contract

Understanding A SAFE Contract

What startups should know when negotiating with investors.

Silicon Valley’s Y Combinator has been a trailblazer in many ways, one of which is pioneering the SAFE contract for startups.

SAFE stands for Simple Agreement for Future Equity. It is a smart way for startups to raise debt-free seed capital. Startups enter into agreements with investors for receiving a certain amount of money today, in exchange for shares that the investor receives at a later date.

The later date in post-money SAFEs is typically the date on which the startup raises a priced equity round, usually their Series A. Standard SAFE agreements also provide for other major events, such as founders selling the company or shutting shop.

SAFEs are easier to execute than traditional priced equity rounds, especially with Y Combinator’s SAFE contract templates. While a SAFE contract is technically supposed to remain unchanged from its original form, it was designed for the United States legal system and may need adjustments when applied elsewhere. Knowing a few key terms can give startups the edge in negotiating a mutually beneficial SAFE contract.

The Valuation Cap

Knowing why a ‘post-money’ SAFE exists requires a slight brush up on SAFE history, but first, it’s important to understand the valuation cap.

Investors and founders negotiate a valuation cap at which the SAFE converts. When the priced round (or any other triggering event) occurs and the valuation of the startup is higher than the valuation cap, the SAFE converts at the agreed upon capped value.

However, if the valuation of the startup is lower than the cap, the SAFE then converts at the actual valuation, so investors end up owning more of the company–their investment now entitles them to a higher stake.

Post-Money SAFEs

A quick history lesson: when SAFEs came out in 2013, startups were raising much smaller seed or angel rounds prior to a priced round. This did not have a major impact on their valuations. With time, however, seed rounds grew to hundreds of thousands of dollars, and had to be accounted for when valuing a startup.

A post-money valuation simply means the total of the pre-money valuation of the company (or the valuation before any priced round was raised) and any new money raised, including via SAFEs.

The post-money valuation cap is one of the more popular types of SAFEs, but there are also discount SAFEs (where the investor receives shares based on a discount instead of a valuation cap), valuation cap and discount SAFEs (where both the valuation cap and discount are considered), or Most Favored Nation (MFN) SAFEs.

Instead of a valuation cap or discount, MFN SAFEs allow investors to adopt the terms of another investor from whom the startup raises funds, if they find those terms favorable. This kind of SAFE comes into play when a startup is especially young and difficult to value.

Pro Rata Rights

Post-money SAFEs come with the optional side clause that gives investors pro rata rights, or rights to purchase additional shares in the priced financing round where the SAFE converts. Pro rata share rights are issued proportionally based on how many shares were issued to the investor on conversion of the SAFE. Investors have the right to purchase only as many additional shares as this ratio allows.

SAFEs Can Get Tricky

The thing about a SAFE is that it dilutes ownership of the startup–but not today. For instance, when founders enter into multiple SAFEs or issue shares, the increasing dilution of ownership tends to escape their scrutiny. Y Combinator partner Kirsty Nathoo provided a common example: by giving out shares via an employee stock ownership plan (ESOP), as many startups do, founders dilute their ownership by a certain percentage.

At this point, SAFE investors still have rights to a specific number of pre-dilution shares, so when the SAFE converts, it changes the capitalization table, and founders end up forfeiting more than they expected.

Technicalities such as these can lead to startup founders finding themselves in a quagmire where they have given up more ownership than they anticipated. Keeping tabs on the cap table becomes imperative when SAFEs or any other convertible instruments are issued. The smart thing to do for founders who cannot do the math, is to hire a lawyer who can.

Header image by Helloquence on Unsplash

SHARE THIS STORY

Share on facebook
Share on twitter
Share on linkedin
Share on email

RELATED POSTS

Mercedes-Benz Launches the New Luxurious CLE Cabriolet

Mercedes-Benz has launched the CLE Cabriolet, building on its heritage of creating four-seater convertible vehicles. This new addition is characterized by its expressive design, advanced technology, and high-quality features, ensuring an enhanced driving experience. The model, which evolves from the CLE Coupé, stands out with its traditional fabric acoustic soft top and distinct high-quality details, making it uniquely positioned in the market. Designed to offer dynamic performance alongside exceptional daily comfort, the CLE Cabriolet supports year-round open-air enjoyment.

4 Companies Reusing Coffee Husk for Eco-Friendly Innovations

A daily cup of coffee is more than just a morning ritual—it’s a powerhouse of energy and health benefits. Beyond keeping you alert, coffee supports brain health, maintains liver function and may even lower the risk of depression. However, the journey of coffee from plantation to mug involves an energy-intensive process that produces significant waste, particularly coffee husks.

Fort Worth Hosts New LG Electronics Facility for EV Charger Assembly

LG Electronics has initiated its first U.S. production facility for electric vehicle (EV) charging stations in Fort Worth, Texas, aiming to bolster the national EV charging infrastructure and generate employment opportunities. The facility’s inauguration was marked by an event attended by Fort Worth Mayor Mattie Parker and LG executives Alec Jang, H.K. Suh and Nicolas Min. This development is part of LG’s strategy to expand its presence in the EV charger market by providing high-quality charging solutions and services.

KPMG Introduces “The Road to Leadership” along with Harvard Business School

KPMG in India and Harvard Business School Publishing Corporation (HBSPC) have announced a collaboration to launch “The Road to Leadership”, a program designed to empower mid-level managers with the skills and insights needed to ascend to leadership roles. This collaboration brings together HBSPC’s rich legacy in leadership education and KPMG’s deep industry experience, offering participants a unique blend of theoretical knowledge and practical insights tailored for the Indian context.

What Are the Negative Impacts of AI on the Film Industry?

The arrival of artificial intelligence (AI) in filmmaking is changing the game, introducing endless possibilities into an industry known for its creativity. Hollywood, known for its glitz and glamour, is already on board, using AI to pick out potential hits through script analysis and predictive analytics. This allows filmmakers to make data-informed decisions on which scripts might win the audience’s hearts.