What is a SAFE?
SAFE: Simple Agreement for Future Equity
SAFE stands for “Simple Agreement for Future Equity”. Traditionally, a SAFE has been a very common instrument for investing in startups in their early stages. As the name suggests, it is a simple agreement that regulates an investor’s investment in a startup. This instrument is very common in the United States, since it facilitates and speeds up the investment process. It is also the instrument used by the prestigious accelerator Y Combinator in San Francisco, to participate in the capital of the startups that enter its program. In Spain and other European and Latin countries however, it is usually more common for investors to me the investment via Convertible Note, a topic that we cover in a separate article. (Link to Convertible Note Article)
Due to the very early stage of the investment, investors prefer to use this type of instrument to save time, save on legal costs, and protect themselves against the dissolution of the company in the event that it does not go beyond the initial stage.
A SAFE is ultimately a type of contract by which an investor contributes a certain amount of capital to a startup in exchange for the promise of having a specific number of shares in the company in the future, as long as the agreed conditions are met in the contract.
One of the keys to this type of contract is that it is generally used for investments in startups in a pre-seed or seed state. Lately due to the current economic downturn, we are even seeing lager state investments done via SAFEs too, in order to avoid the need of setting a valuation for the company, and perhaps, avoiding downrounds.
In the early stages, the use of this formula is very common because it allows the investor to invest in the startup without the need to establish a valuation of the company. As in these stages the valuation of companies is very difficult to obtain, due to the fact that they do not yet have income, products, equipment… It is a great advantage to use the SAFE as an investment instrument. Normally, these instruments usually establish a maximum valuation (valuation cap), which establishes the maximum valuation limit at which the contributed capital will be converted into company shares.
Advantages of Investing Via SAFE
In our opinion, using a SAFE as an investment method in startups is advantageous for both parties, both for the entrepreneurs and for the investor. Among the advantages we can highlight the following.
Speed to close and execution of the investment
SAFEs allow the use of a standard document, which barely requires any changes. This allows the investment round to be closed in a matter of hours or days, without the need to review multiple documents, suggest changes, etc.
Cost and time savings
Raising an investment round is usually very expensive. Typically, you may be negotiating or discussing with various investors, each with their own interests, which will require more legal advise hours, resulting in higher costs. In addition, investment rounds require hiring highly qualified legal advisers who are usually very expensive. Using a SAFE as a document that regulates and standardizes the investment allows generally to avoid lawyers, and to agree on a general and standard agreement with investors. This process will be much faster and wont require as much iteration or revision for its signature and execution. The savings can therefore be several thousand euros.
Less bureaucracy and less intervention by investors
One of the greatest advantages provided by SAFEs is that new investors do not become shareholders at the time of signing, but after a certain time, once the conditions established in the agreement have been met. This is a great advantage for the entrepreneur, since he continues to maintain the status of sole shareholder of the company. This allows you to have some initial freedom to develop the product. In addition, it is very common that initially the startup chooses to apply for loans and grants for entrepreneurs. The SAFEs in these cases allow the entrepreneur not to have to request signatures or information about the investors since only the entrepreneur has shareholder status.
On the investor side its also more favorable. In case the company is not able to go through the initial stages of the startup life, the investors won’t be yet shareholders of the company. Which is very favorable in case of dissolution of the company. Investors won’t be part of the paper work, litigation processes, etc.
It doesn’t accrue interest
One of the main differences between SAFEs and convertible notes is that they do not generate interest. This ultimately saves financial costs for the company, or in the event that the coupon is cumulative, it allows entrepreneurs not to dilute themselves so much.
Finally, it should be noted that in the event of dissolution and liquidation of the company, the SAFE investor is subordinated to all ordinary creditors. This includes investors via convertible notes. The SAFE investor will remain in the same rank as the rest of the investors via SAFE (pari passu) and will only have preference over the main shareholders, in this case the entrepreneurs.