The founders' quick guide to SAFEs

Y Combinator introduced the Simple Agreement for Future Equity (SAFE) to help startups raise money in the early stages, before full equity funding rounds. The SAFE is now the typical way many startups do their first fundraising and has set the market standard for early-stage funding.

Securing funding quickly and on standardised industry terms, without having to spend a lot of money on lawyers means that you have more time and resources to spend on growing your business. Using a SAFE also avoids needing to fix a valuation during the early stages – particularly as your startup probably won’t have grown enough to underpin a full valuation. Instead, the next equity funding round will determine the valuation of your business.

1. What do SAFEs do?

SAFEs allow investors to become a shareholder in your startup in the future once their investment is converted into shares. In return for providing funding now without receiving any shares until your next equity funding round, investors are usually given a discount of around 20% as compensation for the risk. They might also be offered a cap on the valuation, either in addition to or instead of the discount.

2. Don’t forget the valuation cap and converting SAFEs into shares in your topco

A valuation cap is the maximum valuation of a startup when you’re calculating the conversion of the SAFE investment into shares. It can work instead of or alongside a discount (in which case, it is whatever valuation is lower between the discount and the cap).

Here’s a scenario for you to think about:

So, if a SAFE investor invests with a 20% discount and a USD 3 million valuation cap, and at the next equity funding round the startup is valued at USD 6 million, the investor will convert at a USD 3 million valuation (i.e. an effective discount of 50%).

If the startup is valued at USD 3 million, the investor would convert at USD 2,400,000 (a 20% discount) because that discounted valuation is lower than the valuation cap.

3. Most Favoured Nation Rights

Most favoured nation (MFN) rights allow your investors to upgrade their rights if, later down the line, better ones are offered to new investors. This ensures everyone invested in your startup is so on equal footing.

In a nutshell, a SAFE;

 

  • is a great way for early-stage startups to secure investment before full equity funding rounds
  • avoids the need to agree a fixed valuation
  • may give investors a discount and/or valuation cap
  • may sometimes give investors the right to invest in the startup’s next equity funding round (usually an amount equal to its SAFE investment or proportionate to its would-be shareholding in the startup)
  • may sometimes allow investors access to certain information about the startup’s business (e.g., financials)
  • may sometimes grant “most favoured nation (MFN)” rights to investors

Don’t forget:

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You can use Clara to generate a SAFE, create Convertible Loan Notes and generate supporting documents like Board Resolutions and Grant Agreements.

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