All about SAFEs

When it comes to raising venture funding, startups have several popular instruments at their disposal: SAFEs, convertible notes, and NVCA documents for priced equity rounds. In this post, we’ll dive deep into SAFEs.

For the past 8+ years, I have been a corporate lawyer representing startups and venture funds throughout their lifecycle. This includes formation, financings, day-to-day business operations, and exits. I’ve worked both at Cooley and two venture-backed startups as their first legal counsel. I've represented thousands of startups, most of which are in the early stage, and nearly all have raised venture funds at some point. One of the most popular instruments for raising venture funds is SAFEs. SAFEs are often preferred for pre-seed and even seed rounds of financing due to their affordability and speed of execution.

What is a SAFE?

A SAFE, or Simple Agreement for Future Equity, was introduced by Y Combinator (YC) in 2013. It is a concise, open-source financial instrument granting investors the right to receive equity at a future date. This occurs when the company conducts a priced equity financing round and sells shares of preferred stock. At that point, SAFEs convert automatically, and SAFE holders become stockholders.

It's essential to understand that SAFEs are not shares but rather instruments that convert into shares in the future.

When does a SAFE convert into equity?

SAFEs primarily convert into preferred stock during the company’s next priced equity financing round. The conversion terms may include:

• A conversion price discount, or
• A valuation cap, depending on the SAFE form.

Some SAFEs feature a "most favored nation" (MFN) clause, allowing investors to adopt better terms from future convertible instruments issued by the company.

If the startup doesn’t undergo an equity financing round, the SAFE converts during a Liquidity Event (e.g., acquisition, merger, or IPO). In this case, SAFE holders receive the greater of:

1. Their initial investment, or
2. The value based on the SAFE’s valuation cap or discount.

In a Dissolution Event (e.g., voluntary winding up, bankruptcy, or other liquidation), SAFE holders are entitled to repayment of their investment after creditors are paid. However, there may not be significant assets left for repayment in many cases.

Types of SAFEs: Pre-Money vs. Post-Money

The Evolution of SAFEs

• 2013: YC introduced pre-money SAFEs to replace convertible notes. These SAFEs were intended for bridging to priced equity rounds but soon became a common fundraising tool for seed rounds.
• 2018: YC introduced post-money SAFEs to address the growing complexity of SAFE rounds. Post-money SAFEs provide more clarity for founders and investors by explicitly accounting for ownership percentages.

What Do “Pre-Money” and “Post-Money” Mean?

• Pre-Money Valuation: The company’s worth immediately before new investment.
• Post-Money Valuation: The company’s worth immediately after new investment.
• Pre-Money SAFE: Excludes the SAFE investment when calculating ownership percentages. Pre-money SAFEs technically result in less dilution for founders but frequently lead to unanticipated dilution, especially in multiple SAFE rounds.
• Post-Money SAFE: Includes all SAFEs in the capitalization, offering greater clarity and predictability.

Other Key Considerations

1. Raising Amounts Near the Valuation Cap:Raising amounts close to or exceeding the post-money valuation cap can result in negative ownership for founders. For example, raising $5M on a $5M post-money valuation cap would leave no equity for founders.
2. How Much Can a Startup Raise?:Typically, startups raise up to $2M through SAFEs (though I’ve seen outliers go up to $8M, which I don’t recommend). The more a founder raises, the more diluted their ownership becomes.
3. Preparing for SAFE Financing:To ensure a smooth process:
   • Data Room: Prepare a data room with all corporate documents for investor due diligence. Use this free data room checklist.
   • SAFE Draft + Board Consent: Work with legal counsel to prepare a SAFE draft and obtain board approvals.
   • Securities Compliance (For Larger Rounds): File Form D with the SEC and state blue sky filings after closing. For smaller rounds, filings may be deferred based on your risk tolerance.
   • Startup Convertible Financing Package

Which SAFE Should You Use?

In most cases, startups use a post-money SAFE with a valuation cap. This provides clarity on investor ownership and founder dilution.

Find SAFE templates on the Y Combinator website.

If you'd like us to handle your SAFE financing end-to-end, check out our Convertible Financing Package.

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Disclaimer: This post is for informational purposes only and should not be considered legal or tax advice. Consult legal and tax advisors for tailored advice.