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What is a SAFE?

First developed by Y Combinator in 2013, a SAFE grants an investor the right to obtain equity at a future date if the startup sells shares in a future financing. It has been historically used by top startups in Silicon Valley raising money from accredited angel investors. You should only invest in a SAFE if you believe that the startup can raise financing in the future from professional investors.

SAFEs are used by early-stage startups because they delay the difficult task of figuring out how much a startup is worth. It is also a much cheaper and simpler contract than priced equity rounds, which may require months of negotiation and upwards of 30 pages of legalese costing tens of thousands of dollars.

The number of shares you receive is determined at the next priced financing when professional investors – typically venture capitalists – set the price for preferred stock. Then, calculated by using the Valuation Cap and sometimes the Discount Rate, your SAFE often converts into shares at a lower price than the venture capitalists paid, since you invested earlier.

The Valuation Cap is the most important term in this security. It puts a maximum price on the price of the stock - the lower the price, the more shares you will get. If you invest in a startup with a valuation cap of $8 million, and they later raise at a $20 million Pre-Money Valuation, the amount of stock you'll get will be priced off the $8 million number. But, if the next investors value the company at $4 million, that will be your price instead (perhaps further discounted by the Discount Rate ).

Unlike a Convertible Note, a SAFE is not a loan. As such, it does not accrue interest, have a maturity date, or have a legal obligation to be paid back. This makes it a simpler and cheaper way to finance a startup, and it typically better aligns with the intention of most early stage equity investors who never intended to be lenders (convertible notes are rarely if ever paid back in cash despite being a debt instrument – the startup just goes bankrupt).

Further Reading:

There are two main variations of the SAFE.

Y Combinator SAFE

Y Combinator initially developed the SAFE for Accredited Investors investing under Regulation D offerings. Most startups who use this variant only intend to accept funding from perhaps a dozen rich investors, or through many investors investing via a WeFund SPV.

Wefunder Crowdfunding SAFE

Accepting funding from hundreds of direct online investors investing as little as $100 requires a SAFE with several extra protections not common in Regulation D fundraises with Accredited Investors. The Wefunder SAFE treats Major Investors (typically defined as investing between $10,000 and $25,000) much like the Y Combinator variation, but it has no voting rights for Minor Shareholders.

The Wefunder SAFE:

  • Has Repurchase Rights for Minor Shareholders. Except for Major Shareholders, the company may opt to repurchase an investor's SAFE at any time prior to conversion at the greater of the purchase amount or the Fair Market Value, as determined by an appraiser the company chooses. Startups want this because they are scared that venture capitalists may not fund their companies at a later date because they have a "messy cap table".
  • Can be Amended by One Lead Investor. The lack of a maturity date and interest rate negates the need for common amendments of convertible note financings. However, if a particularly complex issue in a follow-on financing requires an amendment to the SAFE, founders are scared they'll be unable to chase down thousands of signatures. The company can designate a Lead Investor Representative, and all investors agree to allow that person to unilaterally amend the SAFE. But that person may not change the Valuation Cap.
  • Grants CEO Power of Attorney for Minor Shareholders. Once the SAFE converts into equity, investors who are not Major Shareholders grant the current CEO a power of attorney to vote all shares and execute any documents on their behalf. This mitigates the potential problem of hundreds of minor shareholders slowing down further follow-on financings.

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