A Simple Agreement for Future Equity (SAFE) is an agreement made between an early-stage startup and a VC or angel investor. In this type of agreement, which usually takes place during the seed fundraising round, the investor pays money now and receives shares of company stock later. Because they involve converting money to equity at a later date, SAFEs belong to a group of financing options known as convertible securities. (We’ll review some of these options later in this guide.)
Why would a founder be interested in SAFEs as a financing tool? Well, early-stage startup founders face an interesting dilemma. They need money from investors but do not yet have a valuation for their startup — and getting one might be prohibitively expensive or impractical. Furthermore, they want to avoid taking on too much share dilution. With a SAFE, a founder can quickly find the cash they need to grow their startup, all while saving on legal costs and pushing the dilution question forward to the next funding round.
Most SAFE agreements are structured so that the investor receives the shares due to them in the next priced round of financing. (As SAFEs are most typically used in early-stage fundraising, this is usually a seed or Series A round.) The number of shares the investor receives is usually based on the valuation of the company at that time, though some SAFEs have a valuation cap that puts an upper limit on how the shares are valued at the time of conversion.
Things tend to change quickly in the world of venture capital, but the SAFE has proven to be surprisingly durable since its launch in late 2013.
The startup accelerator Y Combinator (YC) initially devised the SAFE based on feedback from YC-backed startups struggling to balance their investors’ interests with their own (typically small) appetite for complexity. The vision was to create a “flexible, one-document security” that cut down on the time and money spent negotiating investment terms.
The first SAFEs were typically used by founders and investors looking to get deals done as quickly as possible, but simplicity came at the cost of some certainty. Investors in these “pre-money” SAFEs received a promise to be granted shares at the next financing round, but they didn’t know exactly how much of the company they actually owned.
To alleviate this uncertainty, Y Combinator released the “post-money” SAFE in 2018. This SAFE measures ownership after all the SAFE money is accounted for and thus gives the investor a clearer picture of what percentage of the company they will own once their money is converted into shares.
We’ll explain some key differences between pre-money and post-money SAFEs below, but both types have advantages over other types of funding options. For one, they help to unlock what Y Combinator’s Paul Graham refers to as “high-resolution fundraising,” in which founders can draft separate agreements with each individual investor, with specific terms that make sense for the type of investor and the level of risk they assume. SAFEs are also so standardized and ready-to-roll that the only thing left to negotiate, in most cases, is the valuation cap for the shares in each agreement.
Now that you know what a SAFE is, you may be wondering how it compares to other investment methods available to startups and investors.
These methods can generally be broken down into two types:
Not every funding option fits neatly into these two categories. Convertible notes are debt instruments that offer the ability to get repaid in equity, so they’re a little bit of both.
As you’ve probably guessed, SAFEs fall into the “equity” category. They do not represent a debt to the investor, but rather a promise to the investor to issue equity at a future date. Since a key feature of SAFEs is that they’re convertible, you might think of them as convertible equity (as opposed to convertible debt).
Let’s look at how SAFEs stack up to other funding options typically available to early-stage startups.
A share of stock represents an ownership stake in a company. Common stock and preferred stock are two types of stock a company can issue, and both types of equity can be present in the same company’s cap table.
Venture capitalists and angel investors may ask for preferred stock when investing in startups. They often negotiate for this stock to include voting rights and other powers, such as the right to sit on the board of directors. As you might imagine, these negotiations can be time-intensive, laborious, and costly. Another snag with preferred stock is that issuing stock of any kind requires a formal valuation that an early-stage startup may not yet have.
Given these issues and the relative simplicity of SAFEs, SAFEs are generally considered to be a better option for seed funding rounds. Of course, a SAFE can be structured in such a way that it converts to a certain number of shares of preferred stock when it hits a triggering event (i.e. the next financing round).
Convertible notes are short-term debt instruments oftentimes used in seed financing and venture capital. Like other debt instruments, they typically have an interest rate and a maturity date. Unlike other debt instruments, they offer the holder the ability to get repaid in equity, rather than in their initial investment of money plus interest.
One of the reasons Y Combinator launched the SAFE in the first place was to provide an alternative to convertible notes — specifically, an alternative that avoids the question of an interest rate and pares down the terms requiring negotiation for the sake of simplicity and transparency. Still, convertible notes may have some benefits over SAFEs for investors. They are certainly more customizable in terms of features such as the interest rate. They may also allow for a cash payout or some other benefit to the investor in the absence of triggering events that convert the note into equity. They may also allow the investor to collect extra equity in the form of interest.
The startup accelerator 500 Startups created the Keep It Simple Security (KISS) in 2014 as a response to Y Combinator’s SAFE. They are similar in many respects, but they aren’t exactly the same.
The KISS is perhaps a bit less simple than the SAFE, but it still prioritizes ease and flexibility as far as startup founders are concerned. Investors who plan to invest across multiple rounds may also find the KISS to be an enticing option, as it is structured to provide more benefits to major investors.
Despite the simplicity of the KISS relative to many other types of equity financing, the ubiquitous SAFE remains generally more popular as an option for early-stage fundraising.
We mentioned above that there are two types of SAFE: the pre-money SAFE and the post-money SAFE. We’ve written a whole guide that breaks down the differences between pre- and post-money SAFEs, but here’s a quick summary:
Y Combinator created the post-money SAFE in 2018, largely in response to some of the vagueness associated with its initial pre-money SAFE. Given the additional transparency, it has displaced its predecessor as the preferred option for founders and investors alike.
Spend time in the startup community and you’ll soon learn that post-money SAFEs are the most common way to raise early-stage money. This isn’t because founders are uncreative (they are anything but!). Suffice it to say, the modern SAFE investment effectively balances the interests of founders and investors in a way that few early-stage funding options can.
It can be a lot to ask entrepreneurs and startup company founders to wrap their heads around all the different ways to finance an early-stage startup. And that’s to say nothing of some of the newer SAFE-related investment options out there, such as the Simple Agreement for Future Tokens (SAFT) that’s becoming increasingly popular among web3 startups.
Fortunately, SAFEs are simple by design — and powerful when used the right way. At Pulley, we believe SAFEs can be one of the strongest tools in a founder’s fundraising arsenal, and we’ve built out a ton of our own tools to help you wield them effectively:
Interested in learning more? Schedule your demo today.