Simple Agreements for Future Equity (SAFEs) are a relatively new financial instrument that startups can use to raise capital. SAFE agreements are a popular alternative to traditional convertible debt and equity financing arrangements, which can be complex and time-consuming. In this article, we’ll take a closer look at what SAFE agreements are and how they work.

What Are SAFE Agreements?

A SAFE agreement is a legal contract between a startup and an investor that offers the investor the option to receive equity in the company at a later date, usually when the company raises more capital or is sold. SAFE agreements were introduced in 2013 by the startup accelerator Y Combinator as a way to simplify fundraising for early-stage startups. Since then, they have gained popularity among entrepreneurs and investors alike.

How Do SAFE Agreements Work?

SAFEs typically come with a few key terms. The most important of these is the valuation cap, which is the maximum valuation that the company can have when the investor’s investment converts into equity. For example, if the company sets a valuation cap of $5 million and subsequently raises a round of funding at a valuation of $10 million, the investor’s SAFE would convert into equity at a price based on the $5 million valuation cap, rather than the $10 million valuation of the new round.

Another important term is the discount rate, which gives the investor a discount on the price of the equity they will receive when they convert their SAFE into equity. For example, if the company sets a discount rate of 20%, the investor’s SAFE would convert into equity at a price that is 20% lower than that of the new round.

Lastly, SAFE agreements may also come with a maturity date, which is the deadline by which the SAFE must convert into equity, or the investor must be repaid their investment with interest.

What Are the Benefits of Using SAFE Agreements?

SAFE agreements offer several advantages over traditional convertible debt and equity financing arrangements. First and foremost, they are simpler and faster to set up, which can be a big selling point for startups that need to raise capital quickly. They also provide flexibility in terms of valuation and the timing of the conversion to equity, which can be valuable for both startups and investors.

Another benefit of SAFE agreements is that they typically do not accrue interest, which can be beneficial for startups that are not yet generating revenue. Unlike traditional convertible debt, which accrues interest over time and can be a burden on a startup’s finances, SAFE agreements do not require payments until they convert into equity or mature.

Conclusion

SAFE agreements are a popular and effective way for startups to raise capital without the complexity and bureaucracy of traditional convertible debt and equity financing. For investors, they offer flexibility and the opportunity to invest in promising early-stage companies without the risk of dilution that comes with early-stage equity investments. Overall, SAFE agreements are a valuable financial instrument that all startups should consider when raising capital.