Overall, a SAFE can be a wonderfully simple tool that can be used to raise funds in the early stages. The key, for both founders and investors, is to understand what you`re using and get good advice as you use it. As the examples in this article show, there are some complexities of the „simple“ agreement that can be solved, but usually require some foresight. Without properly considering these questions in advance, you can suddenly convert multiple SAFE, each with different terms, right next to the tipping point between using a discount and a valuation cap, without a clear path to the future, which is the opposite of the goal of using a SAFE. Note that SAFE defines a „discount rate“ and not a discount. This means only 100 minus the discount. A 20% discount equates to an 80% discount rate. The discount rate is like a Nordstrom coupon that says „Pay 80% of the sale price“ instead of „Get 20% off the sale price“. Here`s how Steve thinks about uncovered notes for the vast majority of cases. Early investors want to take risks and help startups, but they need to have solid returns overall.
So if the value of a startup in which they later make an initial investment „runs away“ with an extremely high valuation, it will dilute their investment if there is no upper limit. Therefore, many, if not most, savvy investors will not be able to take the risk of unlimited investment. Instead, they will simply take a wait-and-see approach until the next round of awards, and if things go well and the evaluation makes sense to them, give up the discount. If a value per share is set in equity investing, this is a simple calculation, as shown in the following table: It turns out that the discount is better if the value is lower before money, but if it increases, there is a turning point where the valuation ceiling starts and is preferable. It is important to realize that this turning point is not at the valuation ceiling, but actually has a higher value. Indeed, if we have both a valuation cap and a discount, we do not compare the valuation cap with the valuation agreed by the equity investor, but with the discounted valuation determined above. Before we start talking about how to set the conditions, including the cap, let`s briefly review some definitions related to convertible bonds and SAFERs. Typically, most startups in the early stages will raise their first round with a convertible bond or SAFE – Simple Agreement for Future Equity – instead of a valued stock round. Debt securities and SAFERs are relatively easy to assemble, which postpones (one way or another) the discussion about valuation, and investors can more easily make an investment at an earlier time and price. Adjusting inputs will give you a better understanding of the importance of how discount rates and valuation caps work together in convertible bonds and SAFERs. With this understanding, you can see why these two key terms are often heavily negotiated: they are the basis of an important source of funding for early-stage businesses. A SAFE is not debt financing, so it has NO interest rates or maturity date.
SAFERs solve two problems: (1) no one knows what a company is worth in the early stages, and (2) no one wants to spend a lot of time and money creating elaborate investment documents. A SAFE moves the question of valuation so you can move on, even if the founder and investor have very different ideas about what the company is worth. The SAFE is a short standard document that can be created easily and cheaply. Understanding how the assessment cap and discount work in practice can be better illustrated by working through mathematics. A SAFE is an investment vehicle that converts the value of the holder into the issuer`s equity in the event of certain triggering events. As the name suggests, SAFERs have been designed to be simpler, lighter, and an easier way for founders and investors to quickly align with an investment. Like convertible bonds, SAFERs are popular in early-stage financing because they allow companies to raise funds and investors to invest money without having to evaluate the business before either party knows how much the business is worth. Like convertible bonds, they are sometimes used for bridge financing at a later stage. „Pro-Rata Rights Agreement“ means a written agreement between the Company and the Investor (and, where applicable, the holders of other safes) that grants the Investor the right to acquire its proportionate share of the private placements of securities by the Company as a result of an equity financing, subject to the usual exceptions. Pro rata for the purposes of the pro rata rights agreement will be calculated on the basis of the ratio between (1) the number of shares in the share capital where the investor is located immediately prior to the issuance of the securities and (2) the total number of outstanding shares of the outstanding share capital on a fully diluted basis, calculated immediately prior to the issuance of the securities. Reliance on a future conversion event highlights the risk for an investor to invest in a SAFE, with the aim of ultimately owning an issuer`s capital. If a company fails to secure future equity financing or be taken over, an investor`s SAFE will never be converted into equity.
The SAFE holder is entitled to reimbursement in the event of the dissolution of the company, although it is likely that in this scenario there are no significant assets left to pay to the SAFE holder. A seed investor takes a high risk from the start. This risk is not rewarded if all the investor gets is the right to invest with others later when the company has more value. A valuation cap solves this problem for the investor. A valuation cap sets a maximum enterprise value to determine the percentage of equity the investor receives. Without a valuation cap, the SAFE investor`s percentage of equity continues to decline as enterprise value increases. One of the easiest (and cheapest) ways to invest in a start-up business is often a simple agreement for future equity (SAFE). SAFERs are easy to use and do the job with minimal cost and can work for both individual investors and investor groups. The discount is a percentage in the next round, while the ceiling sets a maximum ceiling for the evaluation of the next round. When this next round takes place, early investors will not get both a discount and additional shares if the cap is exceeded. It`s one or the other, not both. We hear the founders say, „I created a SAFE and inventors get a 20% discount and a $7 million cap.“ They think their first investors will get both.
That`s not how it works. For the shed and ceiling, it`s an OR, not an ET. A SAFE grants the right to receive a certain number of shares in Series A financing. Because SAFE investors invest earlier and take more risk than Series A investors, SAFE investors pay for their shares at a lower price than Series A investors. The valuation cap and discount rate control the discount that SAFE investors receive. If it is a convertible bond, as we mentioned earlier, there is an interest rate on that bond. Typical interest rates are 2-8% and these interest rates are „paid“ in the future note-taking interview. Another important element for debt securities is the maturity date, which is the date on which the bond is „due and payable“ if it has not already been converted. A SAFE is a relatively simple document that startups often use to raise seed capital. A SAFE is a promise to issue a number of shares in the future – „Simple Agreement for Future Equity“.
Unlike a convertible bond, a SAFE is not a debt and therefore has no repayment period and no interest rate. The typical event that triggers the redemption or conversion into shares of the company is the assumption of a classic equity financing by the company. Usually, at the time of the next traditional equity financing after the sale of the Convertible or SAFE Bond, the Convertible or SAFE Bond is automatically due for redemption or converted into shares of the Company. This mechanism is subject to intensive negotiation and may include additional details, such as. B conversion only at the discretion of the investor or in the case of traditional equity financing, which rewards the investor with a satisfactory significant advantage to assume the risk of default in the early stages. A discount rate gives the SAFE investor a discount on what future investors pay for equity at the time of the triggering event. This is a discount on the future selling price. A discount rate of 85% means that the SAFE investor receives their future equity for 85% of what future investors pay, which rewards them for early investment. Finally, to illustrate how the discount rate and valuation cap can be used together, consider a scenario where all of the above details are the same, except that the 50% discount rate and an $8 million valuation cap are built into the convertible or SAFE bond. The calculation of the discount against the assessment ceiling in this scenario would work as follows: $2 million / $8 million = 0.25 and 1 – 0.25 = 0.75. The price per share of the convertible bond or SAFE would then be calculated as $0.75 x $1 = $0.75.
The main function of a SAFE is to allow an initial investment in a company to make the financial bridge until a larger round of financing can be completed, at which point the anticipated investment is converted into shares, with the investor benefiting either from a discount to the purchase price or from a limited value. Convertible bonds have already fulfilled this function; However, they can be complicated because different investors and institutions have their own preferred forms and require separate security arrangements in the case of guaranteed promissory notes. .