The Simple Agreement for Future Equity is a financial instrument created by Y Combinator in 2013 to simplify seed investing as an alternative to convertible notes. A SAFE is similar to a convertible note. SAFEs, however, do not come with an interest rate or maturity date and are not a loan.
SAFEs also allow for high resolution funding and flexibility with key terms such as the valuation cap and discount rate without the legal costs and negotiations typically associated with a more traditional priced round.
As financial instruments, SAFEs carry many of the same features as convertible notes. Startups and their investors include key basic information like the identity of each party or parties to a transaction, how much money is being invested, and the terms of the investment.
Much like convertible notes, SAFEs specify the circumstances under which the capital invested converts to equity. SAFEs may convert upon the liquidation of the company in an acquisition event, the dissolution of the company, or if the company raises a priced funding round.
In terms of liquidation priority, under the standard Y Combinator SAFE documents the SAFE holder is junior to creditors and bondholders, on par with other SAFE holders and holders of Preferred Stock, and are senior to Common stockholders.
Y Combinator makes templates available for four different varieties of SAFE.
A valuation cap is the maximum valuation at which a SAFE shall convert to equity. If a company's valuation fails to meet the valuation cap, the SAFE converts at the lower, actual valuation.
A discount clause grants the investor the right to purchase shares in an equity funding round at a predetermined discount (typically between 15% and 25%) to the price of shares being transacted in the round.
In SAFEs which implement a valuation cap as well as a discount, either of (but not both of) the terms can apply. If the dynamics of the conversion result in an investor getting a greater equity stake using a discount, the discount clause would apply. If the conversion favors the investor converting at the valuation cap, the valuation cap clause would apply.
A most favored nation (MFN) clause grants the holder of the SAFE the right to amend their SAFE, once, to match the most advantageous terms a company has negotiated with other investors. An MFN clause does not allow investors to "cherry pick" deal terms. Apart from the invested amount, a SAFE amended pursuant to MFN would be identical to the SAFE with the most advantageous terms.
The latest version of Y Combinator's SAFEs do not automatically grant SAFE holders pro rata rights in subsequent financing events. Investors must negotiate access to pro rata rights and, if granted, the company and the investor must complete a side letter granting the investor those rights.
Y Combinator's original SAFE documents, released in 2013, were based on a company's pre-money valuation. The new SAFE documents, released in mid-2018, are now based on a company's post-money valuation.
The two terms aren't that different from one another, and reflect different moments in time.
- A pre-money valuation is the value of the company immediately prior to receiving new or additional investment.
- A company's post-money valuation is the value of the company immediately after receiving new or additional investment.
In general, a company's post-money valuation is equal to its pre-money valuation plus the additional cash it raised in a funding round. A company with a $10 million pre-money valuation which raised $3 million in new financing would be valued at $13 million, post-money.
Y Combinator states their motivation for updating the SAFE documents from pre-money to post-money in its user guide for the documentation.
[The] post-money safe is the best way for both companies and investors to understand ownership. The original safe was standardized on a pre-money basis and inclusive of the Series A option pool increase, which made it difficult for founders to calculate precisely how they were being diluted when raising money. The answer to “how much of the company are we selling” was dependent on a recursive loop of how much was raised on other original safes, plus a hypothetical assumption about the Series A option pool increase that would be negotiated years later. These unknowable elements meant that founders had a hard time planning out their fundraise so that they could sell an intended and expected portion of their company. Founders might intend to sell around x% of their company. But they didn’t have the best tools to accomplish this goal, which meant that they often ended up selling a lot more than they really wanted to, when they didn’t have to.
This distinction between pre- and post-money has further implications for certain deal terms.
- Valuation caps are "post" all of the money a company raised via SAFEs. It is not post all the money raised in a qualified equity financing round (typically a Series A round).
- The post-money valuation cap is "post" the options and options pool existing prior to the qualified equity financing round. It is not also "post" the new or increased options pool that may be negotiated as part of the qualified financing round.
