SAFE Agreements
The Simple Agreement for Future Equity (SAFE) is a popular financing option for startup and emerging companies. SAFEs come with a number of advantages, but there are also some risks and other consequences that business owners and investors alike must consider.
In short, a SAFE is an agreement in which an investor contributes cash to a company in exchange for the right to participate in a future equity offering of the company. The agreement will define what sort of event triggers an equity offering and the number of shares that the investor will have the right to acquire when that event occurs.
While the specific terms of each SAFE can be unique depending on how the agreements are written, all SAFEs generally have the following features and favorable provisions:
- SAFEs allow the company to raise necessary cash and potentially increase the valuation without immediately giving up an equity stake.
- Unlike convertible notes, SAFEs do not have any interest accrual or repayment requirements.
- SAFEs are relatively easy to understand, draft and execute.
- If and when the equity offering occurs, investors will receive their shares at a discounted rate per the terms of the agreement. Certain SAFEs accomplish this by setting a valuation cap in the agreement.
Like any other financing instrument, SAFEs have risks that all parties should take note of. On the investor’s side, the primary risk is that the equity offering may never be triggered. Generally, the triggering event for the equity offering will be the occurrence of a major financing, sale, or liquidation event. If the company is not able to reach such a point, then the investment would be lost, and the company would not be required to repay it. On the company’s side, management must note that in order to compensate investors for this risk, the terms of a SAFE will always provide that the investor is to receive their shares at a discounted rate or based on a valuation cap. The company should consider the potential effect that these terms could have on its valuation.
Lastly, management must ensure that all executed SAFE agreements are included in the company’s cap table. While the equity has not yet been issued, SAFEs represent potentially dilutive instruments that existing investors and potential future investors need to be aware of when making decisions and planning for the future.
