A COMPREHENSIVE GUIDE TO UNDERSTANDING THE BASICS OF THE SIMPLE AGREEMENT FOR FUTURE EQUITY(SAFE)
Okay stop clutching your pearls, we are not robbing your safe. This is an article that clarifies the elements of the simple agreement for future equity (SAFE) in simpler terms.
The SAFE is a financing contract used by a startup to raise capital in its early stage and enables the investor to convert the investment into equity in a future financing round. Essentially, SAFEs solve the challenge of valuing a startup in its inception or formative stages.
However, for many founders, it can still be overwhelming to understand how SAFEs work. Now let’s try to demystify the complicated language and confusing calculations in the SAFE.
Origin of the Simple Agreement for Future Equity (SAFE)
The SAFE was originally created by Y Combinator to simplify the process of early-stage startup fundraising. The initial SAFE created by Y combinator was based on a pre-money valuation cap.
Hold on !!! What is a valuation cap? If there is no official valuation in a SAFE financing, why is there a valuation cap? The valuation cap sounds just like a valuation. YES!! We are thinking on your behalf.
Okay let’s briefly address the valuation cap, shall we?
A valuation cap sets the maximum value at which the SAFE will convert into equity. SAFEs come with valuation caps to reward early-stage investors for taking investment risks on a startup in its infancy.
However, with the pre-money SAFEs, there is a good deal of uncertainty regarding the equity ownership of the investor. Investors have to wait for a future priced round to ascertain the extent of their equity ownership.
This led to the advent of the post-money SAFE which treats SAFE financings as independent seed rounds, which are not contingent upon the next equity financing round.
The major advantage of a post-money SAFE is that investors can decide the percentage of equity they will acquire, once the SAFE is converted into shares and founders can ascertain how their shares would get diluted by the SAFE.
For example:
If an investor gives you 1 million for 10 % equity ownership. The valuation cap on the SAFE would be 10 million. (calculated as The investment amount (1m) divided by the percentage(10%) = 10,0000,000
Variations of the Post money Safe
The Post money SAFE is highly recommended for the clarity and certainty it provides. The post-money SAFE can be used in different forms, which will be considered below;
a. Valuation Cap only
This type of post-money SAFE sets the valuation cap at which the investment amount will convert into equity.
The conversion of shares in a Post money SAFE is calculated thus;
Number of shares = Purchase amount (Investment amount) divided by the Safe price
The safe price = Post-Money Valuation Cap divided by the Company’s shares. Hypothetically, if the post-money valuation cap is 10m and the company has 5 million shares. The safe price per share will be 10,000,000/5,000,000 = 2
The number of shares will be the Investment amount (Let’s say 1,000,000) divided by the SAFE price per share(2). The number of shares will be 500,000 shares.
As an alternative , calculating the investor’s ownership percentage will be;
Ownership percentage = Investment amount divided by Valuation Cap
1,000,000/10,000,000 = 10%
b. Discount, No Valuation Cap
This is a SAFE with a negotiated discount rate that applies when converting this safe into shares. The discount rate gives investors a discount on the price per share when their SAFE converts into equity.
For example;
If a Series A investor pays $5 per share during a priced round, a SAFE holder with a 20 percent conversion discount will get to purchase their shares at $4 per share.
c. Valuation Cap and Discount
This is a SAFE with a negotiated post-money valuation cap and a discount rate. Either the post-money valuation cap or the discount rate applies when converting this safe into shares in an equity financing round, depending on which calculation is most advantageous to the investor.
d. MFN [Most Favoured Nation], No Valuation Cap, No Discount
This is a SAFE with no post-money valuation cap and no discount rate. If the company subsequently issues SAFEs with provisions that are beneficial to the investors holding this safe (such as a valuation cap and/or a discount rate), the investor may choose to amend its SAFE to reflect the terms of the later-issued SAFEs.
However, the MFN provision typically provides only one opportunity to amend the safe, not multiple opportunities as the company continues to issue additional SAFEs.
GETTING STARTED WITH SAFES
SAFEs are an effective and easy way to fundraise for your company during its seed round. At ABO law, we work closely with our early-stage clients in their capital-raising efforts to provide counsel in structuring financings in a manner that works for the company and its potential investors.
Our lawyers are conversant with the evolving models of early-stage financings, including SAFEs. If you’re interested in raising money with a SAFE, you may contact us via our email; info@abolaw.ng or call us on 08109168055.