What is a SAFE? (Simple Agreement for Future Equity) What types of SAFE are there?

As founders and entrepreneurs look to raise money, many of them turn to a streamlined and standardized option, the Simple Agreement for Future Equity (or SAFE).

Broadly speaking, there are three types of SAFEs, each with their own unique features and implications. Additionally, several ancillary documents can accompany SAFEs, further influencing the terms and outcomes of the investment. This post explores the key differences between types of SAFEs and the potential ancillary documents involved.

What is a SAFE?

As the name suggests, SAFEs are monetary investments for future equity. In short, they are agreements where an investor provides the company with an investment, agreeing that the amount of the investment will convert into equity at a later date (typically a later “priced round” of investment) under the terms described in the SAFE.

The largest question, then, is under what terms that conversion occurs. The three primary permutations of a SAFE answer that question in different ways:

Valuation Cap SAFE

The first form of a SAFE is a “Valuation Cap” SAFE, wherein the investor and Company agree to cap the Company’s valuation for purposes of the SAFE’s conversion. In essence, that cap functionally guarantees that the investor will receive no less than a certain percentage of total equity, while retaining the investor’s right to obtain a larger percentage of total equity in the event the conversion event is lower than the cap.

Following an agreed-upon cap, the remaining question is whether that cap is effective before or after an investor leading a priced round conveys their investment to the Company. A “Post-Money” Valuation Cap SAFE gives a SAFE investor more assurance of their expected equity stake after an investment, whereas a “Pre-Money” Valuation Cap SAFE can result in dilution of the SAFE investor’s equity based on how large the investment coming in through the priced round is.

In summary, negotiation of Valuation Cap SAFEs focus on two questions:

  • What should the Valuation Cap be?
  • Is that Valuation Cap “Pre-“ or “Post-Money”?

Discount SAFE

Instead of focusing on a specific equity target, investors may prefer a “discount” SAFE, which offers investors a specified discount on the future equity financing round’s price per share but does not include a valuation cap.

  • Key Term: Discount Rate: The percentage discount on the price per share compared to the next equity financing round.

“Most Favored Nation” (or MFN) SAFE

This form of SAFE lacks numerical conversion terms, eschewing them in favor of clause that essentially allows a SAFE investor to “step into the shoes” of the most favorable terms a subsequent investor negotiates.

Sometimes, the MFN language is instead layered into a Valuation Cap or Discount SAFE, giving the investor a floor on how favorable their terms can be and the upside of a successful later negotiation.

Ancillary Documents

SAFEs are not equity themselves, merely the right to convert a monetary investment into equity at a later date. Accordingly, SAFE investors lack the rights traditionally associated with an equity investment in a company. Accordingly, many of these investors  will require, as a condition of entering into the SAFE, that the company grant them important rights to bridge that gap. Some of these common side agreements are:

  1. Pro Rata Side Letter

This document grants investors the right to maintain their ownership percentage in future financing rounds by participating in a priced round on a pro-rata basis. It is often included to protect investors from dilution and ensure they can continue to invest in the company’s growth.

  1. Board Rights Agreement

Some SAFEs may be accompanied by agreements that grant the investor the right to a board seat or observer status. This can be crucial for investors who want to have a say in the company’s strategic direction. With that said, this is a right companies are reticent to grant until later priced equity rounds because of the organizational and bureaucratic cost associated with board members outside of the company.

  1. Information Rights Agreement

This document provides investors with the right to receive regular updates on the company’s financial performance and business activities. It ensures transparency and keeps investors informed about their investment, but these reports and disclosures may amount to a significant burden and distraction for early bootstrapped companies.

Key Differences and Considerations

Understanding the differences between these types of SAFEs and ancillary documents is essential for both founders and investors. Each type of SAFE offers a different balance of risk and reward, and the choice of form can significantly impact the company’s cap table and control structure.

  • Founders should carefully consider which type of SAFE aligns best with their fundraising goals and future plans. The decision should be based on factors such as the desired level of investor engagement, potential dilution, and the need for quick capital.
  • Investors need to assess the terms of the SAFE and any ancillary documents to ensure they align with their investment strategy and risk tolerance. The presence of pro rata rights or MFN provisions can make a significant difference in the attractiveness of the investment.

Conclusion

SAFEs provide a flexible and efficient way to raise capital, but understanding the nuances of each type and the accompanying documents is crucial. By carefully considering these elements, both founders and investors can make informed decisions that support the long-term success of the business.

Connor Richards

Connor is an attorney at Odin Law and Media building his practice focused on the video game, entertainment, and esports industries. Prior to joining Odin, Connor worked at Ernst & Young, assisting multinational corporations with a variety of tax matters. Connor also actively participates in the Esports Bar Association and as a guest on the occasional industry podcast. He can be reached at connor at odin law dot com.

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