By: Fabiola Torres
SAFE stands for Simple Agreement for Future Equity. It is a legal document used to raise funds from investors in a startup. A SAFE is a type of investment contract that gives investors the right to purchase shares in the startup later, typically when the company raises a subsequent funding round or reaches a specific milestone. SAFEs are often used for early-stage fundraising, as they are simpler and less expensive to set up and manage than other instruments.
Under North American legislation, where this kind of contract comes from, it contains diverse legal and financial terminology, but in summary it is briefly explained what a SAFE is for:
- A SAFE is an investment agreement that allows investors to commit to investing in a company in a future round of investment.
- SAFEs do not have interest or expiration terms, and do not give the right to vote.
- Instead, investors get preferred shares in a future investment round, such as a Series A or Series B investment round.
- SAFEs are more flexible and less expensive to issue and manage than traditional convertible bonds.
- SAFEs are common in seed capital, as they allow companies to raise funds before they have an accurate valuation or a solid capital structure.
- The terms of a SAFE can vary, but typically include an automatic conversion to preferred shares in a future round of investment, a cap on the price per share at the time of conversion, and liquidation priority in the event of an event of liquidity (such as an IPO or an acquisition).
- SAFEs also often include a “cap” clause that sets a ceiling on the price per share at the time of conversion.
- Some SAFEs also include a “discount” clause that establishes a discount in the price per share at the time of conversion.
- SAFEs are used to give investors an incentive to invest early in a company by giving them access to a lower price in a future investment round.
- The important elements that we must consider in this class of documents are, among others:
- The valuation of the company: the SAFE is based on a future valuation of the company, and the investor must know and analyze the valuation proposed by the startup when planning the future investment round.
- Dilution: It must be considered how it will be affected by dilution in the future, that is, how its percentage of ownership in the company will be reduced with new rounds of investment.
- Timing of conversion: The SAFE will need to specify when the conversion will occur, either when a specific milestone is reached or in a future round of funding.
- The right to acquire shares: SAFE gives the investor the right to acquire shares in the company at a future date but does not guarantee that the investor will acquire shares.
- Preferential liquidation: SAFE can specify how assets will be distributed in the event of liquidation and mention the proposed liquidation process.
An investment in a startup is not an investment for a conservative profile, because although it is a company with great potential and projections, many of them burn money rapidly, and do not always find the necessary investors, or their business model does not have enough sustainable competitive advantages over time, rather they are temporary advantages that any other competitor can replicate.
Thus, we see new businesses based on technology or artificial intelligence, but which can be quickly identified as imitable upon entering the market, for which purpose new competitors may be seen in a short time. Hence the importance that the startup contains innovative characteristics, competitive advantages that allow it to raise sufficient capital over time and develop before new competitors are in the market.
In short, SAFEs are financial instruments generally used by investors who decide to participate in a Startup. They are structured in such a way to raise capital and take risks. Given their complexity and specialization, it is recommended that investors or entrepreneurs be assisted by expert lawyers for the structuring of such instruments.