S.A.F.E.
The Simple Agreement for Future Equity
Consider a S.A.F.E. Agreement instead of selling present equity ownership.
A startup company that wants to raise money from investors during early seed rounds should consider a Simple Agreement for Future Equity.
What is a Simple Agreement for Future Equity?
The SAFE is an investment contract. The investor agrees to give money to the startup business when the contract is signed. The startup business agrees to give the investor the right to receive stock equity in the company, either at a set time in the future or upon the completion of specific events.
The typical trigger for the investor getting equity (stock shares) in the startup is the release of preferred shares of company stock. Preferred stock is typically issued at an IPO during a round of future equity funding.
Valuation: SAFEs are great when there is uncertainty as to the value of a company. The SAFE defers that valuation to a future date when a greater amount of data is available for a fair market determination. It is normal for a SAFE to include a valuation cap within its terms.
Why business owners Use S.A.F.E. agreements
A SAFE allows startup founders to receive investment money at an early stage in the business process. Money is raised to create a going enterprise that makes profits and accomplishes its goals. A startup CEO must utilize the best option (or options) available for investment capital. The startup’s capital investment options are:
Founders prefer a SAFE for several reasons. First, the founder’s own personal assets are not used. Second, the terms of a SAFE are usually better for the startup founder than terms typically found with straight debt, or a convertible note. Third, other options, such as a SAFT, crowdfunding, or accelerator funding may not be practical given the startup’s circumstances. Fourth, the SAFE allows founders flexibility on how the company raises capital.
Why investors use S.A.F.E Agreements
Large profits can be realized for an early investor who enters into a SAFE with a successful startup.
The Discount Rate. The risk the investor takes by giving money early is offset by getting a “discount rate.” This is the right to stock the investor bargains for, but at a lower price than offered to later investors (with the later investors incurring [presumably] lower risk because the startup will be more established at that future time). The discount rate is typically not described as a nominal figure (say, $5 per share and not $7 per share at IPO). Rather, the discount rate is usually described as a percentage discount from the IPO value (like, 20% off the IPO price).
A S.A.F.E. contract can be a better option than a Convertible Note
The SAFE is typically a better option than a Convertible Note for startup founders. Three features distinguish a SAFE from a convertible note.
Loan vs. Warrant.
Maturity Date.
A SAFE has no maturity date. There is no set, specific time in the future when one can look at the calendar and declare “this is when I get my equity interest in the company.” This SAFE flexibility allows the startup to “get it right” by developing its business to the point where later equity/money raising rounds are done at a planned, proper, fully developed, not rushed in time. The startup likes this time flexibility. The investor likes its increased equity value at IPO.
Accruing Interest.
Then, the investor has little or no return for its investment. However, with a convertible note, the investor has a debt enforceable in the normal fashion, even if the company fails. A convertible note may even be backed up by guarantees relating to the personal assets of the startup founders. … not so with a SAFE. Thus, ceteris paribus, a startup business is better off using a SAFE compared to a convertible note. An investor is better off with a convertible note compared to a SAFE, ceteris paribus.
Should a Startup use one? Y - combinator's S.A.F.E. template
The Y Combinator SAFE was drafted by a team of lawyers with experience. It was drafted to apply to many different circumstances for many different businesses. “A Jack of All Trades is Master of None,” it is said. So too, is the problem with any Form Contract. The Form forces you to bargain for terms you don’t need. Terms are included that do not apply to your circumstances. You wind up obligated to perform duties, about which no one cares. You incur legal liability, risk breaching contract, relating to terms that do not need to be in your SAFE. Important terms that really should be included in the SAFE are absent … because you never had a lawyer tailor it. It is just a form, made for someone else, in a different time, under different circumstances. Does your startup business reflect your personal, specific contribution? If so, then its legal documents should as well.
You are pitching your business to investors who see dozens (or hundreds) of applicants. Candidly, many businesses use the Y combinator (or similar) form SAFEs. Stand out from the crowd! Only one contestant wins the prize in any zero sum contest. Your business will have limited opportunities to display its uniqueness. Spend a little time and money to have a tailored SAFE drafted. The changes may be more advantageous to your potential investor with you giving up nothing you value. That increases your chances of success. It also stands you out from the “crowd.”
Investment agreements between those with the money and those with the business are always negotiated. All such agreements are unique. Opportunities change. Businesses differ. Personnel differs. Your market may be trending up or down. What works fine today may be too much or too little tomorrow. A standard SAFE agreement takes no real world circumstances into account. You are not the ostrich with its head in the ground. The agreements to which you bind yourself, your business, and your partners must be the same.
A SAFE, depending upon its terms, will have consequences on how and how much taxes are paid. Some are characterized as equity (everyone loves a good financial gains tax!). Another SAFE may be better classified as a debt instrument. There is even the variable pre-paid forward contract option. No one loves to deal with tax issues. However, one should take the time and effort to manage tax liability through the SAFE while the option remains.
Legal Issues with a S.A.F.E.
When you sign a SAFE, you are creating an investment contract governed by the Securities Act of 1933. This means regulation and compliance with the Securities and Exchange Commission. This means you can face civil and criminal penalties for non-disclosure, false disclosure, failing to file the appropriate
The SAFE is a contract. This means you can be sued for breach of its terms. You face tort liability for any wrongful actions you take with the investor (your new business partner). Risks include: paperwork, etc.
Founders prefer a SAFE for several reasons. First, the founder’s own personal assets are not used. Second, the terms of a SAFE are usually better for the startup founder than terms typically found with straight debt, or a convertible note. Third, other options, such as a SAFT, crowdfunding, or accelerator funding may not be practical given the startup’s circumstances. Fourth, the SAFE allows founders flexibility on how the company raises capital.
Repurchase SAFE Rights
A SAFE can contains terms where the startup company has the right to repurchase the stock it sold the investor in the SAFE contract, rather than converting it to stock. These types of terms are beneficial to the startup business (if it becomes highly valuable) and are less beneficial to the investor. The timing, and value of the repurchase right is part of the negotiation process, if such a clause is to be included at all.
Dissolution Terms
Many startups fail. Many companies end up in bankruptcy or simply dissolve. Yet, even in dissolution, assets remain. What is to be done with those assets? Should the founders get them? Should the investors get them? Should there be a distribution dividing by contribution to the failed venture? The SAFE should contain provisions in the event of a failure to which each party will agree.
Voting Rights and Management Control
Did you forget that a SAFE sells company equity? What if the company is member-managed? That means each and every stockholder must agree to each material decision. That means each stockholder can assert management orders in the business. You do not want a Member Managed Organization if you have a SAFE.
Even if the company in question is manager managed, the investor will hold a sizeable stake in the company upon conversion. How much control do the parties wish to cede at IPO? These are terms that must be negotiated in advance. If not, then the typical SAFE will create, at least an influential minority owner.
Tax Issues with S.A.F.E. Agreements
The typical S.A.F.E. does not qualify as a debt instrument.
Think of a S.A.F.E. Agreement as more of a genus, than a species. There are:
A S.A.F.E. is really a forward derivative contract.
What may be an appropriate tax classification of one type of SAFE may not be appropriate tax classification of another.
Several different tax classifications apply to S.A.F.E. Agreements. These include:
Why tax implications matter with a S.A.F.E.
For example, the holding period for the investor matters when the stock is sold. Consider:
The crypto lawyers at Whale.Law negotiate and draft custom S.A.F.E. agreements tailored to the circumstances of each client. Our cost is greatly outweighed by our clients’ increased chances of success, the reduced risk, and the greater monetary value of our clients’ businesses. Contact us if you enter into serious investor negotiations.
Trial lawyer Matt Hamilton graduated from the University of Missouri in 1995 with Science degrees in Logistics, Marketing, and Business Administration. Juris Doctor, 1999.
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