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.
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.
Here are some specifics about this instrument.
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.
There is no interest rate on a SAFE because it is not a debt instrument.
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.
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.
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.
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.
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.
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.
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,
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