What is a SAFE and how do startups attract investment?

SAFE stands for Simple Agreement for Future Equity — an agreement for future equity in a company. It was developed by the accelerator Y Combinator in 2013. The document is designed to simplify fundraising for startups in their early stages.

How SAFE Works

An investor provides funds to a startup but does not receive shares immediately. Instead, they acquire the right to a future equity stake. Typically, a SAFE converts into shares when the company conducts a priced equity financing round.

For example, a startup raises $100,000 via a SAFE. Later, the company moves to the next round and receives investment from new investors. The terms of the SAFE determine the price at which the initial investment converts into shares and the number of shares the early investor will receive.

Unlike a standard loan, a SAFE typically does not accrue interest or require repayment by a specific date. However, the investor assumes the risk of losing their investment, while founders assume the risk of dilution of their ownership stake.

Key Terms to Know

There are several concepts in a SAFE that affect the investor's future equity stake.

Valuation Cap — Maximum Company Valuation. This is the maximum valuation used to calculate the share price upon SAFE conversion. If the startup's valuation exceeds the cap by the next round, the early investor can receive shares at a lower calculated price.

Discount — Discount Rate. This allows an early investor to purchase shares at a lower price than new investors in the subsequent round. For example, with a 20% discount, the share price for the SAFE holder will be 20% lower than the price set for new investors.

Post-money SAFE — Agreement with Post-Money Valuation. This format helps determine in advance what portion of the startup the investor will receive under these agreements. Y Combinator has used post-money SAFE as the standard format since 2018.

MFN — Most Favored Nation. This clause allows an investor to receive more favorable terms if the startup later enters into other SAFE agreements. A SAFE with an MFN clause can be used without a valuation cap or discount, but the specific implications depend on the terms of the document.

Not all these provisions are necessarily present in a single agreement. The terms depend on the chosen SAFE format and the agreements between the parties.

You can calculate the potential equity stake using the Y Combinator SAFE Calculator.

Why Startups Choose SAFE

The main advantage of a SAFE is simplicity. Such an agreement is usually easier to negotiate than a full-fledged investment agreement. The startup also does not need to determine the exact company valuation immediately.

Y Combinator provides standard SAFE forms for free. This helps founders prepare for investor negotiations and close deals faster.

What Are the Risks?

While a SAFE simplifies fundraising, it can lead to a reduction in the founders' equity stake. If a startup enters into multiple such agreements, their cumulative effect can be significant.

Furthermore, a SAFE does not guarantee that the company will raise the next round or that the investor will recover their invested funds. Y Combinator's standard forms are also not automatically suitable for every country. Startups from Central Asia should verify the legal terms in accordance with the legislation of their country of registration.

Before signing the agreement, it is advisable to review the official Y Combinator guide to SAFE and consult with a lawyer specializing in venture capital investments.