A SAFE is a relatively simple document that startups commonly use to raise seed capital. A SAFE is a promise to issue a certain number of shares in the future - “Simple Agreement for Future Equity”. Unlike a convertible note, a SAFE is not debt, and so it has no deadline for repayment and no interest rate.
Although they’re “simple”, there’s still a learning curve. To read and understand the SAFE template you need to jump back and forth between the “events” section and the “definitions” section. Since that can be tiresome, I’ll run through the SAFE line-by-line and do the jumping for you. You can grab a copy of the SAFE document here. Specifically, I’ll be running through the Safe: Cap and Discount version.
All blockquotes in this post are taken directly from the standard Form SAFE document.
SAFEs are already founder-friendly documents, but I’ll offer a few tips on negotiating SAFEs to that can make life a little easier for founders.
The “Legend” - An All Caps Warning
THIS INSTRUMENT AND ANY SECURITIES ISSUABLE PURSUANT HERETO HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), OR UNDER THE SECURITIES LAWS OF CERTAIN STATES. THESE SECURITIES MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED, PLEDGED OR HYPOTHECATED EXCEPT AS PERMITTED UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT OR AN EXEMPTION THEREFROM.
This is a warning to investors. It essentially says: this SAFE is an illiquid, private company investment. It can’t be re-sold except under very specific circumstances.
Intro Paragraph: Who and How Much
This first paragraph states who is investing and how much, and is followed by the Valuation Cap and Discount Rate. These are critical deal terms.
THIS CERTIFIES THAT in exchange for the payment by [Investor Name] (the “Investor”) of $[ __ ] (the “Purchase Amount”) on or about [Date of Safe], [Company Name], a [State of Incorporation] corporation (the “Company”), hereby issues to the Investor the right to certain shares of the Company’s capital stock, subject to the terms set forth below.
The “Valuation Cap” is $[__].
The “Discount Rate” is [100 minus the discount]%.
A SAFE grants the right to receive a certain number of shares in a Series A financing. Since SAFE investors are investing earlier and taking more risk than Series A investors, the SAFE investors will pay for their shares at a lower price than the Series A investors. The Valuation Cap and Discount Rate control how big a discount the SAFE investors get.
Discount Rate. The discount rate is like a coupon you might use at a store. A 20% discount is the same as a 20% off coupon at Nordstrom. If Series A investors pay $1.00 per share, then the SAFE investors buy their shares at $0.80.
Note that the SAFE defines a “Discount Rate”, not a discount. This just means 100 minus the discount. A 20% discount is the same as an 80% Discount Rate. The Discount Rate is like a Nordstrom coupon that says “pay 80% of the retail price” instead of “get 20% off the retail price.”
Valuation Cap. The Valuation Cap is an upper limit on the price per share a SAFE investor will pay for Series A stock. It’s defined in terms of the company’s market cap rather than share price. The valuation cap is usually between $2,000,000 - $10,000,000. A higher number is better for the company (generally).
The Discount Rate and the Valuation Cap are the main moving parts to a SAFE. They are the terms you would normally negotiate with an investor. The rest of the SAFE document defines the mechanics of how and when the SAFE investor receives her Series A shares.
Liquidation Overhang. Here’s a quick negotiation point. A valuation cap can lead to a Liquidation Overhang problem. This is a scenario where a SAFE or Note investor ends up with much more liquidity preference in their Series A stock than they actually paid for. You can negotiate for the SAFEs to convert into a separate “sub-series” of Series A. This series “A-2” stock would be the same as normal Series A stock, except for a lower liquidation preference. This solves the liquidation overhang problem, but adds some complexity to the transaction.
1. Events: Series A, Acquisition, Bankruptcy
After the SAFE investor signs the SAFE and wires her funds, the SAFE sits quietly on your cap table until one of three major events trigger it into action: (a) a Series A financing, (b) an acquisition, and (c) a bankruptcy.
1(a) Equity Financing
The SAFE will convert into equity upon an an “Equity Financing”. This will usually be the startup’s Series A financing.
(a) Equity Financing. If there is an Equity Financing before the expiration or termination of this instrument, the Company will automatically issue to the Investor a number of shares of Safe Preferred Stock equal to the Purchase Amount divided by the Conversion Price.
If there is an “Equity Financing” (Series A), then the SAFE Investor is issued a certain number of shares of “Safe Preferred Stock.” To figure out the number of shares, we need to know the Purchase Amount (the amount paid for the SAFE) and the “Conversion Price” (this takes some calculation).
“Conversion Price” means the either: (1) the Safe Price or (2) the Discount Price, whichever calculation results in a greater number of shares of Safe Preferred Stock.
The Conversion Price is one of two prices: the “Safe Price” or the “Discount Price”, and the SAFE Investors get to use whichever price is lower.
The “Safe Price” refers to the valuation cap price. It is defined as:
“Safe Price” means the price per share equal to the Valuation Cap divided by the Company Capitalization.
The Valuation Cap is set out at the top of the SAFE. It’s usually something like $5,000,000.
The Company Capitalization refers to the number of (1) outstanding shares (assuming all options are exercised) plus (2) all of the shares in the employee stock plan. More specifically, it is defined as:
“Company Capitalization” means the sum, as of immediately prior to the Equity Financing, of: (1) all shares of Capital Stock (on an as-converted basis) issued and outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants and other convertible securities, but excluding (A) this instrument, (B) all other Safes, and (C) convertible promissory notes; and (2) all shares of Common Stock reserved and available for future grant under any equity incentive or similar plan of the Company, and/or any equity incentive or similar plan to be created or increased in connection with the Equity Financing.
Putting that together, the Safe Price is essentially the Valuation Cap divided by the number of outstanding shares.
Next, let’s look at the Discount Price. It is defined as:
“Discount Price” means the price per share of the Standard Preferred Stock sold in the Equity Financing multiplied by the Discount Rate.
There are a few defined terms here. The Standard Preferred Stock is just the stock the normal Series A investors are buying. The “Equity Financing” is usually the Series A. The Discount Rate is defined at the top of the SAFE, and usually something like 80%.
If the startup’s valuation at the Series A is lower than the Valuation Cap, the Safe Investors will be paying for their Series A shares at the Discount Price (the Series A price multiples by Discount Rate).
In addition to the pricing mechanics, the “Equity Financing” paragraph sets out a few more terms.
1(a) (continued) In connection with the issuance of Safe Preferred Stock by the Company to the Investor pursuant to this Section 1(a): 1(a)(i) The Investor will execute and deliver to the Company all transaction documents related to the Equity Financing; provided, that such documents are the same documents to be entered into with the purchasers of Standard Preferred Stock, with appropriate variations for the Safe Preferred Stock if applicable, and provided further, that such documents have customary exceptions to any drag-along applicable to the Investor, including, without limitation, limited representations and warranties and limited liability and indemnification obligations on the part of the Investor; and
This section says that the SAFE investor will sign the same Series A docs as the Series A investors. It also says that the Series A docs will have customary exceptions to the “drag along” provisions.
1(a)(ii) The Investor and the Company will execute a Pro Rata Rights Agreement, unless the Investor is already included in such rights in the transaction documents related to the Equity Financing.
After a Series A, the former SAFE holders (now series A stockholders) will have the right to buy stock in the Series B financing. These Pro rata rights are like an option to allow the former SAFE holders to maintain their pro rata ownership share of the company. The exact type of pro rata rights is set out under the definition of “Pro Rata Rights Agreement”:
“Pro Rata Rights Agreement” means a written agreement between the Company and the Investor (and holders of other Safes, as appropriate) giving the Investor a right to purchase its pro rata share of private placements of securities by the Company occurring after the Equity Financing, subject to customary exceptions. Pro rata for purposes of the Pro Rata Rights Agreement will be calculated based on the ratio of (1) the number of shares of Capital Stock owned by the Investor immediately prior to the issuance of the securities to (2) the total number of shares of outstanding Capital Stock on a fully diluted basis, calculated as of immediately prior to the issuance of the securities.
Negotiation Point: Having a lot of small investors with pro rata rights will add extra administrative hassle and legal costs. Instead of giving all SAFE investors pro rata rights, you might set a minimum dollar threshold. E.g., only investors who put up at least $50k will get pro rata rights.
What all Entrepreneurs Need to Know About Pro Rata Rights. Mark Suster, 2014.
The Many Flavors of Seed Investor “Pro-Rata” Rights. Jose Ancer, 2014.
1(b) Liquidity Event
This section sets out what will happen if the company is acquired before a Series A financing.
(b) Liquidity Event. If there is a Liquidity Event before the expiration or termination of this instrument, the Investor will, at its option, either (i) receive a cash payment equal to the Purchase Amount (subject to the following paragraph) or (ii) automatically receive from the Company a number of shares of Common Stock equal to the Purchase Amount divided by the Liquidity Price, if the Investor fails to select the cash option.
If you sell the company before a Series A, then SAFE investors either (i) gets the amount she paid for the SAFE, or (ii) converts the SAFE into shares of common stock at the valuation cap, and then sells those shares in the acquisition.
This paragraph goes on to discuss some contingencies that might occur if the SAFE investor picks the 1(b)(i) cash-out option but the company doesn’t have enough cash available to pay the full amount.
1(c) Dissolution Event
This section sets out what will happen if you go bust before a Series A financing.
1(c) Dissolution Event. If there is a Dissolution Event before this instrument expires or terminates, the Company will pay an amount equal to the Purchase Amount, due and payable to the Investor immediately prior to, or concurrent with, the consummation of the Dissolution Event. …
If the company dissolves before a Series A, it will distribute some cash to the SAFE investors. In reality, if a startup fails before a Series A, there probably isn’t any cash left to distribute.
1(d) Termination. This instrument will expire and terminate (without relieving the Company of any obligations arising from a prior breach of or non-compliance with this instrument) upon either (i) the issuance of stock to the Investor pursuant to Section 1(a) or Section 1(b)(ii); or (ii) the payment, or setting aside for payment, of amounts due the Investor pursuant to Section 1(b)(i) or Section 1(c).
The SAFE terminates when the investor is issued Series A shares or gets paid cash per any of the provisions above. This means a SAFE can potentially hang around for a long time.
This can be a problem. If several years go by between the SAFE and the Series A, and the company is doing well, then the Valuation Cap can be much higher than the Series A valuation. This would give the SAFE investors a windfall. One way to avoid this is to do a small (but Bona Fide) equity financing before the Series A. Even if the startup isn’t desperate for cash, it can helpful to do a small financing to convert the SAFEs at an appropriate price.
2. Defined Terms
Section 2 sets out the defined terms. Rather than go through them line by line, I’ve tried to address the defined terms in context above.
3. Company Representations
This section sets out some facts that the startup is confirming are true. If they’re not true, the startup may be committing fraud.
3(a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation, and has the power and authority to own, lease and operate its properties and carry on its business as now conducted.
The startup has filed all the appropriate incorporation paperwork with the Secretary of State of Delaware (or whatever state it’s incorporated in).
3(b) The execution, delivery and performance by the Company of this instrument is within the power of the Company and, other than with respect to the actions to be taken when equity is to be issued to the Investor, has been duly authorized by all necessary actions on the part of the Company. This instrument constitutes a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or affecting the enforcement of creditors’ rights generally and general principles of equity. To the knowledge of the Company, it is not in violation of (i) its current certificate of incorporation or bylaws, (ii) any material statute, rule or regulation applicable to the Company or (iii) any material indenture or contract to which the Company is a party or by which it is bound, where, in each case, such violation or default, individually, or together with all such violations or defaults, could reasonably be expected to have a material adverse effect on the Company.
The startup’s board of directors has approved the SAFE financing, the SAFE doesn’t violate the startups internal governing documents or any laws,
3(c) The performance and consummation of the transactions contemplated by this instrument do not and will not: (i) violate any material judgment, statute, rule or regulation applicable to the Company; (ii) result in the acceleration of any material indenture or contract to which the Company is a party or by which it is bound; or (iii) result in the creation or imposition of any lien upon any property, asset or revenue of the Company or the suspension, forfeiture, or nonrenewal of any material permit, license or authorization applicable to the Company, its business or operations.
Issuing the SAFE won’t create any problems with any prior court judgment, law, or any previous debt documents the company has signed.
3(d) No consents or approvals are required in connection with the performance of this instrument, other than: (i) the Company’s corporate approvals; (ii) any qualifications or filings under applicable securities laws; and (iii) necessary corporate approvals for the authorization of Capital Stock issuable pursuant to Section 1.
The startup doesn’t need to get any special approval to issue this SAFE.
3(e) To its knowledge, the Company owns or possesses (or can obtain on commercially reasonable terms) sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, processes and other intellectual property rights necessary for its business as now conducted and as currently proposed to be conducted, without any conflict with, or infringement of the rights of, others.
The startup doesn’t know of any major intellectual property issues with it’s technology. E.g., the founders didn’t steal technology from a prior employer.
4. Investor Representations
This section sets out some facts the Investor will represent are true.
4(a) The Investor has full legal capacity, power and authority to execute and deliver this instrument and to perform its obligations hereunder. This instrument constitutes valid and binding obligation of the Investor, enforceable in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or affecting the enforcement of creditors’ rights generally and general principles of equity.
If the investor is a fund or trust, the person signing is authorized to sign for the investor.
4(b) The Investor is an accredited investor as such term is defined in Rule 501 of Regulation D under the Securities Act. The Investor has been advised that this instrument and the underlying securities have not been registered under the Securities Act, or any state securities laws and, therefore, cannot be resold unless they are registered under the Securities Act and applicable state securities laws or unless an exemption from such registration requirements is available. The Investor is purchasing this instrument and the securities to be acquired by the Investor hereunder for its own account for investment, not as a nominee or agent, and not with a view to, or for resale in connection with, the distribution thereof, and the Investor has no present intention of selling, granting any participation in, or otherwise distributing the same. The Investor has such knowledge and experience in financial and business matters that the Investor is capable of evaluating the merits and risks of such investment, is able to incur a complete loss of such investment without impairing the Investor’s financial condition and is able to bear the economic risk of such investment for an indefinite period of time.
The investor promises that it is an “accredited investor”. An accredited investor is someone who is rich enough (according to US securities laws) to risk their money in unpredictable, illiquid investments. More specifically, an investor is “accredited” if:
- They have a net worth of over $1 million, excluding the value of their primary residence, or
- Their annual income exceeds $200,000 for the last two years, or
- Their joint annual income with their spouse exceeds $300,000 for the last two years.
A business is an accredited investor if all of the equity owners are accredited investors. There are a few other types of accredited investors, but these are the big ones.
5(a) Any provision of this instrument may be amended, waived or modified only upon the written consent of the Company and the Investor.
You can’t modify the SAFE with just a phone call. You need a written amendment signed by the investor and the company. As a founder, you may want to amend this section to say that the SAFE may be amended with the written consent of the Company and the Majority Holders (and then define the term “Majority Holders”). This way, if you issue several SAFEs and you need to make minor adjustments, you don’t need to track down every single small investor and get a signature. This can save on administrative and legal expenses.
5(b) Any notice required or permitted by this instrument will be deemed sufficient when delivered personally or by overnight courier or sent by email to the relevant address listed on the signature page, or 48 hours after being deposited in the U.S. mail as certified or registered mail with postage prepaid, addressed to the party to be notified at such party’s address listed on the signature page, as subsequently modified by written notice.
Formal notices can be sent by email or U.S. mail.
5(c) The Investor is not entitled, as a holder of this instrument, to vote or receive dividends or be deemed the holder of Capital Stock for any purpose, nor will anything contained herein be construed to confer on the Investor, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action or to receive notice of meetings, or to receive subscription rights or otherwise until shares have been issued upon the terms described herein.
The investor doesn’t have stockholder rights (until the SAFE converts into equity).
5(d) Neither this instrument nor the rights contained herein may be assigned, by operation of law or otherwise, by either party without the prior written consent of the other; provided, however, that this instrument and/or the rights contained herein may be assigned without the Company’s consent by the Investor to any other entity who directly or indirectly, controls, is controlled by or is under common control with the Investor, including, without limitation, any general partner, managing member, officer or director of the Investor, or any venture capital fund now or hereafter existing which is controlled by one or more general partners or managing members of, or shares the same management company with, the Investor; and provided, further, that the Company may assign this instrument in whole, without the consent of the Investor, in connection with a reincorporation to change the Company’s domicile.
The investor can’t sell the SAFE to someone else, but the investor can transfer the SAFE to another related investment vehicle. E.g., investor “AwesomeFund, LLC” might transfer the SAFE to related entity “AwesomeFund Holdings 2017, LLC”. The startup can’t transfer the SAFE to a different startup, unless it’s just reincorporating in a different state (but is otherwise the exact some company).
5(e) In the event any one or more of the provisions of this instrument is for any reason held to be invalid, illegal or unenforceable, in whole or in part or in any respect, or in the event that any one or more of the provisions of this instrument operate or would prospectively operate to invalidate this instrument, then and in any such event, such provision(s) only will be deemed null and void and will not affect any other provision of this instrument and the remaining provisions of this instrument will remain operative and in full force and effect and will not be affected, prejudiced, or disturbed thereby.
This is standard contract boilerplate. If any one clause of the SAFE is invalidated by a judge, it doesn’t kill the entire SAFE, it only kills that one clause.
5(f) All rights and obligations hereunder will be governed by the laws of the State of [Governing Law Jurisdiction], without regard to the conflicts of law provisions of such jurisdiction.
This sets out the governing law for the SAFE. You would normally enter the state where your main office is located or else Delaware. This is a “choice of law” clause, not a “choice of jurisdiction” clause. That is, the investor can sue the startup in courts located in any state, but whatever court they choose will need to apply the relevant state laws from the state set out in this clause. I.e., the investor can sue the startup in a California court but that court would need to apply Delaware law (if DE was selected in this clause).
The (Big) Problem with Post-Money SAFEs. In 2018, Y Combinator changed the terms of its standard SAFE. The terms are now less favorable to startups, particularly if they raise multiple SAFE rounds before a Series A financing.
Reviewing the SAFE Investment Instrument. Gordon Daugherty, 2013. SAFEs reviewed from an investor’s perspective.
What is a SAFE (Simple Agreement For Equity) and how do I use it for Seed Financing?. John Bautista, 2015.
Why Notes and SAFEs are Extra Dilutive. Jose Ancer, 2017. SAFEs will dilute your common stock more than an equivalent seed equity round.