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If you’ve considered venture capital, you’ve likely come across SAFE (Simple Agreement for Future Equity) notes. SAFE notes allow founders to get venture capital (VC) money right when they need it while pushing the paperwork, cost, and time required of an equity round to a later date.
In this article, we’ll guide you through everything you need to know about SAFEs. How do SAFE notes dilute your business? How can you negotiate a valuation cap that won’t limit your business in the future? What are the long-term implications of a SAFE note?
Key takeaways:
- SAFE notes only turn into equity at a conversion event, like your next round of funding or an IPO.
- Pre-money SAFEs calculate company capitalization without the current SAFE round, making it difficult to understand how much equity investors own and how much you’ll be diluted; post-money SAFEs calculate capitalization including the current SAFE round, making it easy to understand dilution. The latter has grown in popularity in recent years.
- Keep your cap table organized at all times — you don’t want to collect multiple SAFEs and get hit with dilution later down the line.
- Read our other guides to learn more about the process of raising venture capital and more on the key details of your term sheet.
How does a SAFE note work?
The SAFE note was first created in 2013 by Y Combinator. It’s primarily used by early-stage startups before their seed round. SAFEs allow investors to fund a company in exchange for a stake in a future equity round. A standard SAFE investment is generally equivalent to 15% in equity.
SAFEs can make it easier to close checks from interested investors. Unlike traditional venture capital rounds, which require founders to find lead investors or potentially wrangle several VCs into the same round, a SAFE is built to help you close a deal on the spot.
The standard SAFE today is five pages long and is straightforward (after all, the “S” stands for simple). Most of the time, the only thing you’ll need to negotiate on a SAFE is your valuation cap. Valuation caps can be negotiated based on the amount of risk that an investor is taking on with a SAFE — things like a proven product or incorporation can reduce that risk.
Bear in mind: As you fundraise, you might come across the convertible note. Like SAFEs, a convertible note is convertible security, meaning it’s only activated at a later date. Unlike SAFES, convertible notes act like debt — they gather interest, require repayment, and need to be paid off by a certain date. If they’re not paid off in time, they can even trigger bankruptcy. They’ve fallen out of popularity in recent years in the technology industry.
Discounts and valuation caps
SAFE investors get future equity at discounts — like a bonus for believing in your company’s early potential. They also get to negotiate a valuation cap, which is a ceiling on your startup’s valuation that will be used to calculate a SAFE investor’s future equity.
Some founders give each SAFE investor a different valuation cap depending on the value they’re adding; others stick to one valuation cap per round of SAFEs to keep calculations easy.
Discounts and valuation caps work together. Here’s an example:
An investor puts $500,000 into your company through a SAFE note. They get a discounted rate of 20% and you decide on a valuation cap of $2 million. You go on to raise your seed round in a few years and your lead investor sets a valuation of $4 million. Because of your SAFE investor’s discount, they will get your shares at $0.80 a share (a discount of 20%) — or 625,000 shares to match their initial investment of $500.000.
Conversion events
SAFEs only turn into equity shares at a conversion event. There are a few common conversion events:
- Conversion during financing: When your startup raises its next round of financing, SAFEs convert to equity. Your company will get a new valuation and your SAFE investors will receive shares based on the agreed-upon rates.
- Conversion in a company sale/IPO: If your company is acquired or goes public, the SAFE is converted. This event is considered a complete exit, and investors have the option of a payout or getting their SAFE converted into equity.
The number of shares that shareholders get when they convert is determined by the SAFE price. Keep in mind: If the price per share differs between the discounted rate and the valuation cap rate, an investor can choose to go with the better rate.
The SAFE price is calculated by dividing the valuation cap by the company capitalization. The company capitalization is a company’s total value — the sum of all shares of capital stock and common stock.
SAFE price = valuation cap / company capitalization.
Pre-money and post-money SAFEs
Today, there are two types of common SAFE notes: pre-money and post-money. Pre-money and post-money SAFEs calculate company capitalization at a different time, which changes the SAFE price.
Pre-money SAFE: In a pre-money SAFE, the company capitalization does not include the current SAFE note. Company capitalization is calculated before the SAFEs come in (hence, “pre-money”). This makes it impossible to calculate how much ownership the founder, team, and investors have.
Post-money SAFE: The post-money SAFE treats SAFEs as independent financing rounds, which means ownership is measured after SAFEs are closed. Company capitalization includes SAFEs (hence, “post-money”). Post-money SAFEs allow you to calculate different ownership stakes and exactly how much you’ve been diluted with each note.
Y Combinator replaced its original pre-money SAFE with a post-money SAFE in 2017, explaining that seed rounds had increased in complexity and size. Seed-stage startups were no longer using SAFEs as bridges to their next round; SAFE money was often expansive and dynamic enough to act as its own round.
Remember: Even if you opt for a post-money SAFE, it’s important to keep a clean cap table and keep up with where ownership is going. Ask your lawyer for a “pro-forma” cap table that will show you how much each individual and fund will get in equity at different exit times.
Other terms to look out for
There are other terms to look out for.
In recent years, some investors (namely Y Combinator, which invests in companies in its accelerator with a SAFE note) have started introducing MFN provisions in SAFE notes.
MFN (most favored nation) provisions allow SAFE note investors to get the same terms as those that come after them. This means that they’ll be able to match the best terms you give to any future investors.
Pro-rata rights: Pro-rata rights allow an early investor to maintain their equity stake in future investment rounds. If a SAFE investor has a 15% stake in the startup, whenever there’s a funding round in the future, they will be given the option to invest again to maintain their 15% share.
Liquidity event: Liquidity events include startups getting acquired or going public. If this happens before a SAFE converts, investors will either receive cash or stock equivalent to the shares they’ve purchased. Liquidity preferences will also indicate who cashes out first in case of a liquidity event.
Dissolution event: In a dissolution event, a company has shut down. SAFE investors receive compensation from the company’s remaining funds. Any compensation that goes beyond the company’s ability to pay is considered a loss.
How do I run a SAFE round?
Make sure you’re registered as a corporation: This is almost table-stakes for running a company raising venture capital—corporations can scale, issue equity to employees, and go public. Only corporations (and not LLCs or sole proprietors) can use SAFEs.
Set a valuation cap: Decide how much money you’ll need (for example, $1M) and the amount you’d be willing to dilute your business by (for example, 15%). Your valuation cap can be calculated by dividing the money you’ll need by your anticipated dilution. In this case, you might set a valuation cap of $5.7M pre-money (before the SAFE) and $6.7M post-money (after the SAFE). Keep in mind that you will likely need to negotiate this number.
Get a safe note template and fill out the concrete parts: Y Combinator offers a few formats. Fill out details like your bank wire instructions so you can share your SAFE as soon as you’re ready to go.
- Valuation cap, no discount
- Discount, no valuation cap
- MFN, no valuation cap, no discount
- Valuation cap and discount
Start soliciting interested investors: Research, research, research. The process of finding SAFE investors is similar to that of finding investors for your venture capital round.
Execute the document: Once you’ve finalized an investment, execute the SAFE note. Don’t forget to include it in your company’s cap table.
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