Raising Capital in the Early Stages: Convertible Equity—The SAFE

Last week’s post covered raising cash using convertible debt (CD). This week, we’ll cover the SAFE or Simple Agreement for Future Equity.

SAFE Basics

Developed by Y Combinator in 2013, the SAFE is a relatively simple agreement that can be executed quickly to allow early-stage companies to raise capital. Using a SAFE, investors provide cash in exchange for the right to obtain company stock in the future when a Preferred equity round is raised or when the company gets acquired. It is not a debt instrument and has no maturity date nor interest; however, it does provide both investors and founders some of the benefits of a convertible note without some of the drawbacks.

SAFE Specifics

Here are some specifics about this instrument.

Amount

SAFE amounts are usually up to about $2.0 million. Similar to CD, the SAFE will convert into equity in the next round, so the SAFE amount raised should be no more than about 15% to 20% of your forecast next round of equity.

If you raise too much capital in a SAFE, it may take up a significant portion of the equity round when it converts, reducing the ownership percentage the next round investors receive and potentially nixing the deal. Also, you cannot place a “qualifying round value” clause in a SAFE; they always convert as part of the next round event.

Interest

There is no interest rate on a SAFE because it is not a debt instrument.

Discount Percentage

A discount, typically 20%, may be offered on a SAFE. This gives investors an incentive to invest early, rewarding them with more shares than next round equity investors for the same amount of money invested.

Valuation Cap

A valuation cap may be offered on a SAFE. The cap sets the maximum pre-money valuation of the company at conversion, thereby defining the minimum equity ownership percentage the SAFE investor will own once the conversion is complete.

Conversion

A SAFE will be converted to equity at the next round raise based on the discount rate or valuation cap—if included—whichever is more favorable to the investor. If a “change of control” occurs before a Preferred equity raise, the SAFE holder can convert into common stock or cash-out at the agreed on multiple of the capital invested.

Here are the key pros and cons of raising money using a SAFE.

SAFE Pros

Faster and less expensive to raise capital, as there is less paperwork required than for a priced equity round.
Money can be raised in stages and used immediately; a one-time closing is not required.
Overall valuation discussions may be deferred until the next round raise.
Early investors get rewarded for their contribution with a discount or valuation cap.
For the company, there is no forced maturity date nor interest rate.

SAFE Cons

Raising too much in a SAFE can make it hard to raise your next equity round.
Considering a valuation cap may defeat some of the purpose of using a SAFE.
Investors may consider a SAFE more risky than CD as there is no fixed maturity date and no interest.

Key point: Raising capital using a SAFE is faster and less expensive than a priced equity round and is usually more beneficial to the company than raising convertible debt. Nevertheless, a SAFE is still complex and requires experienced counsel to ensure that you avoid potential problems raising future rounds.

Summary

Raising capital with a SAFE is another good option to consider for your early stage, providing that you structure it well and are aware of the risks.

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Do you need advice on how to raise capital? Are you considering what type of investment to use and how to raise the money? Schedule a one-hour call with us here to discuss how we can help.

Until next week!

All the best,