The Simple Agreement for Future Equity or “SAFE” agreement has become a popular means of investing in early stage ventures. The SAFE was created in part by the team at Y Combinator in an effort to address the problems posed by attempting to assign a valuation to early stage ventures – lack of data, operating history, revenues, etc. The theory behind the SAFE goes, in part, that a future “priced” funding round will accurately set a startup’s valuation and the discount typically applied to the investment made through SAFE will, in turn, accurately reflect the true valuation at which the SAFE investment was made.
While some will contend that a SAFE does not represent debt nor equity, I personally cannot agree that the SAFE bucks 200+ years of collective understanding of basic economics. Drawing from accounting interpretations, my contention is that the SAFE creates a hybrid debt offering – a prepaid, contingent right to acquire a company’s securities at a future date at a set price. Or, alternatively, the SAFE investment is one big derivative which the company must carry as debt on its balance sheet and record at fair value, marked to market periodically.
A sample SAFE agreement can be found below:
You can also find the full range of Y Combinator’s documents here.
The fundamental premise underlying the SAFE agreement is that the startup will ultimately raise additional capital. For that reasons, one will find SAFE agreements most often used in seed rounds or crowdfunding offerings, where valuation is unclear. The standard SAFE will grant the investor the right to receive capital stock, typically preferred stock, of the startup at a discount to the subsequent “priced” round of financing. By way of an example, assume a SAFE investment of $50,000 with a stated discount of 50%:
In this simplistic example (typical discounts range from 10-30% only), the SAFE investor “buys” into the first priced round – Series A, at a 50% discount, or $0.50 per share, based on a pre-money valuation of $9,000,000. On paper at least, the SAFE investor has doubled his investment of $50,000. To simplify things even further, if, for example, the SAFE invested had opted for a direct equity investment and, without the benefit of data, invested into the company at a (incorrect) perceived pre-money valuation of $18,000,000 (i.e., $2.00 per share), the investor would be left with only 50,000 shares at $1.00 per share after the Series A, all things being equal. Thus, the SAFE investor “wins” when his perceived pre-money valuation is lower than the pre-money valuation of the Series A.
Another element of the SAFE to consider is the “valuation cap.” This entitles the SAFE investor to equity priced at the lower of the valuation cap or the pre-money valuation in the Series A. The concept behind the valuation cap is to further reward the SAFE investor for assuming the greater perceived risk of the seed stage investment. Using the overly simplistic example above, the SAFE investor may employ a valuation cap of $5,000,000 – meaning the equity delivered would be delivered at the valuation cap, not the pre-money valuation of $9,000,000. In some cases, the SAFE investor will employ both a valuation cap and discount, reserving the right to choose the most favorable valuation between the two.
From my vantage point, the obvious advantage of the SAFE to a startup is that it is not a convertible note – perhaps the most common early stage funding vehicle. A convertible note carries with it the legal obligation to make interest payments and the repayments of principal at particular times, subject to the ramifications of a default. The SAFE effectively hasn’t any deadline – absent provisions for certain liquidity events or liquidation. It may be a forgone conclusion that the startup will seek to close a priced financing round, but the time period in which to do it is basically open.
Moreover, and perhaps more importantly, from a practical perspective, when it comes to early stage financing, how much leverage does a startup truly have? With the overwhelming majority of startups, an expensive early stage round is almost a foregone conclusion. As the incredibly average and otherwise overrated Steve Miller once sang, “go on, take the money and run …”
As always, your questions and comments are welcome – Cheers, AT ([email protected])
A former professional rugby player, Adam S. Tracy brings over twenty years’ experience as an attorney, consultant and dealmaker with a particular focus on cryptocurrency, digital products, payments and immersive corporate structures. As an accomplished executive and advisor to high risk merchants and stakeholders, Adam has proven himself as a results oriented, decisive leader with proven success advising early market entrants, technology adapters, as well as established participants across a wide range of verticals. Adam Tracy’s attack-first personality allows him to excel in dynamic, demanding environments including complex corporate negotiations, distressed environments and regulatory investigations.
In addition, Adam S. Tracy also has a successful track record co-founding high risk industry ventures, building & leading cross-functional teams, and spearheading diverse corporate transactions. A serial entrepreneur, Adam has successfully started and created exits across a wide swath of markets, including various mobile SaaS ventures, nutraceuticals, peer-to-peer payment systems, and several telemarketing-based ventures. Moreover, as a recognized expert in the payments field, Adam Tracy has been a blockchain and digital currency evangelist and influencer since the early days of Bitcoin.
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Adam S. Tracy earned his Bachelor of Science in Computer Applications and Bachelor of Science in Finance from the University of Notre Dame. He subsequently earned his Masters in Business Administration from the DePaul Kellstadt Graduate School of Business, while concurrently earning his Juris Doctorate from the DePaul College of Law. Adam lives outside Chicago with his with his wife, son, four dogs, and two cats.
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