Capital is the bloodline of every business, and startups need a lot of it. There are numerous ways founders and CEOs raise funds to run the business. That being said, a SAFE is one of the ways startups can raise seed capital. However, the critical question is, what is a SAFE?
What is a SAFE?
A SAFE stands for simple agreement for future equity. It’s a convertible security that founders and business CEOs use to raise money for a new business venture. Through SAFEs, business founders receive money from investors in exchange for the future value of stocks.
SAFEs have an origin from the Silicone Valley as Y Combinator first created them in 2013. The goal was to enable startups to raise seed capital without the obligation that comes with debt. Therefore, this means SAFEs are not debts!
In addition, there are four types of SAFEs. These are cap, no discount Safes, discount, no cap safes, cap, and discount safes, and MFN, no cap, no discount safes.
Other Characteristics of a SAFE
A SAFE is a five-page document divided into five sections. The first section is about what constitutes different events. Events are happenings like equity financing or company liquidation during the SAFE. So, this section outlines the rules of engagement and what to expect around these events.
The second section is about the definition of terms. This section explains all details in regards to the SAFE. For example, you may not know the meaning of company capitalization. Section two of the SAFE is where you want to go for the answer.
The third section is about the company representations. This is where you’ll find explanations for how the company has been formed and what type of company it is. In a nutshell, this section contains important information about the company that investors should know.
The fourth section is about investors’ representation. This section outlines who an investor is and how they should relate to the company. It also has an agreement section where the investor confirms they’re accredited investors. Finally, the last section contains the legal stuff about SAFE.
SAFES are known to have little to no significant negotiations. Negotiation is only involved when the business owner determines how much money the investor should put into the business and the valuation cap.
SAFE Notes vs. Convertible Notes
Unlike SAFE notes, convertible notes are short-term debts that convert to equity in the future. Ideally, an investor loans a startup some money and gets a reward for it in the form of equity in the company after 18 to 24 months.
According to rules around convertible notes, they can convert under two situations. This can be done automatically or at the investors’ discretion, provided the maturity date is reached. Compared to convertible notes, SAFE notes are better for raising capital for startups because they’re simpler and don’t involve maturity dates or interest rates.
Nonetheless, convertible notes can be beneficial in certain circumstances depending on the type of business and investor location. Some investors naturally incline towards convertible notes, so it makes sense to consider this option if you’re eying them for seed money.
That being said, the benefits of SAFE notes supersede convertible notes, meaning they’re the best choice for startups. So, if you’re torn between SAFE notes and convertibles, here’s the quick rundown of why you should opt for SAFE notes.
- No debt involved
- Little to no negotiations are required
- Becomes part of a business’s capitalization table
- Flexible and not time-bound
Despite the benefits that come with SAFE notes, there are drawbacks to consider. One, they’re only feasible in incorporated companies, and two, since maturity is not pre-determined or guaranteed, investors are likely to lose their investment. This scares many investors way! If you’d like to learn more or make inquiries about SAFE notes, contact the Law Office of Elliot J. Brown now!