Capital funding remains one of the biggest reasons startups can struggle early on. How and where to raise money is something many entrepreneurs will always have to deal with. A new type of fundraising opportunity may help ease these struggles: the SAFE investment vehicle. A Simple Agreement for Future Equity (SAFE) is a newer, more creative way companies are trying to raise money.
What is a SAFE investment?
A SAFE is an investment vehicle created by the Y Combinator in an attempt to simplify early stage funding and reduce the costs associated with the funding round. SAFEs are intended to work similarly to and essentially replace convertible notes, with a few key differences.
SAFE vs. convertible note
SAFE investments maintain the flexibility of a convertible note, yet address some of their complex issues. Similar to convertible notes, investors fund the company and receive a SAFE agreement versus upfront equity. The SAFE entitles them to future shares of the company if and when a triggering event occurs. The common triggering events are the company raising equity capital, an acquisition or an IPO.
While this type of agreement is similar to a convertible debt agreement in the ultimate conversion of non-equity investment to an equity investment, a SAFE is not a debt instrument. It does not accrue interest and there is no expiration or maturity date, so this cuts down on some of the legal and accounting costs dealing with such items.
Smaller document, less cost
SAFE investments have some elements of convertible debt and some of a warrant. In contrast, a SAFE agreement is often accomplished in only a five or six page legal document, while convertible debt agreements and warrants can bring with them complicated and robust legal paperwork. As founders can attest, more paperwork equals more cost. In early funding rounds, the high cost of these more traditional funding vehicles can be prohibitive.
Pros and cons for investors
The simplicity of SAFEs and the associated costs savings are making them more and more popular with startup companies in the fundraising circuit, but some investors are still skeptical of the agreements. Many investors argue a SAFE does not offer much investor protection. For example, if a triggering event never occurs, the investor will never receive equity.
Also, since they are not debt instruments, the investor is not protected if the company does not have a triggering event or in the unfortunate event the company does not make it. Under a convertible debt agreement, the investor is at least set to receive interest payments over time, or accrued interest to be paid at maturity or as part of the equity conversion. They will also receive repayment of the loan if note maturity occurs before the triggering event.
While some investors are skeptical of SAFEs, the limited stipulations, feasibility and a chance to help a startup from the beginning are the reasons these investments can still be attractive to investors. Some companies are enticing investors to invest with a SAFE with favorable terms for the equity conversion, such as valuation caps as well as discounts. More and more investors are seeing SAFEs as a cost-effective way for startups to raise their early funding rounds and investors to ultimately end up with equity at a nice discount.
There is no doubt that SAFEs will continue to increase in popularity in the early stage funding world. Be on the lookout for the next blog post in our series on SAFE investments highlighting the accounting and tax implications of these investments. If you have any questions on SAFEs or would like to discuss them for your startup, please contact an Anders startup advisor.
