Simple agreements for future equity (SAFEs) are a great alternative to the convertible note. Instead of spending hours negotiating interest rates, maturity dates and security interests, SAFEs offer a quick, easy alternative. But as we know, it is always better to be safe than sorry so here are our hot tips.
What's in the SAFE?
As the name suggests, SAFEs are simple. Investors fund a company, and in return they are given shares at a later date. Unlike its older sister, the convertible note, a SAFE is not considered debt finance. This means investors can't register a security interest and instead hold a contractual right to shares in the future. Typically, equity converts based on a predetermined valuation cap or discount once a liquidity event occurs based on the amount of money that has been invested.
1. Valuation cap Spend time thinking of the right valuation cap. If you're the investor, make sure the cap is limited to the proportion that you are willing to take for your investment. If you're the company, make sure the valuation cap isn't so low that you end up giving away too much of your company once it hits it big.
2. Liquidity events The events that will trigger the shares being issued might be:
1. a future round of capital raising
2. a trade sale
3. an IPO
4. or consider even a capped date or term (while perhaps not so common in a SAFE, we suggest an investor think about whether they want to include one so the investor doesn't end up in noman's land if a liquidity event never happens).
3. Timing Make sure you get the timing right depending on the different trigger events. For example, an investor should get their shares before a sale event or IPO but in the case of a future capital raise the investor should get their shares at the same time as the incoming investors.
We think it's safe to say that the SAFE is a great alternative to debt financing. Unlike banks or loan providers most angels and venture capitalists are in the business of investing and not lending. It is for this reason that investors find that SAFEs have a greater psychological appeal in comparison to convertible debt.