What is a SAFE?

A SAFE, short for simple agreement for future equity, is a contract in which an investor pays a company today in exchange for the right to receive shares later, when the company sells shares at a set price in a financing round. A SAFE is not a loan: it carries no interest, has no maturity date, and gives the investor no shares and no vote until the day it converts.

The instrument comes from the United States, where the accelerator that introduced the form in 2013 still publishes it as a free standard document, with versions for companies in Canada, the Cayman Islands and Singapore. The mechanics described here are those of that standard form, which a negotiated SAFE may change clause by clause. This article is general information, not legal, tax or investment advice, and securities law outside the United States follows its own rules.

How does a SAFE work?

A SAFE works in two moments: the investor wires the purchase amount when the agreement is signed, and the company issues shares for that amount later, when a defined event occurs. Between the two moments the investor holds a contractual right, not stock.

The standard form names three events. The first, and the one everybody plans for, is an equity financing: a round in which the company sells preferred stock at a fixed valuation, usually called a priced round. On that day the SAFE converts automatically into preferred stock, at a price set by the SAFE's own terms. The second is a liquidity event, meaning a sale of the company or a public listing before any priced round. The third is a dissolution. Each has its own payout rule, covered further down.

Until one of those events happens, nothing else does. No interest accrues. No date arrives on which the company must repay. In the form filed on the SEC's EDGAR system as an exhibit by companies that have used it, one clause says the investor is not entitled, as a holder of the SAFE, to vote or be deemed a holder of capital stock. The same form passes through one shareholder-like right: if the company pays a dividend on its common stock, the SAFE holder receives a matching amount.

That absence of a clock is the reason founders use the instrument: a SAFE is a few pages long and can be signed with one investor at a time, each for a different amount. The price of that convenience is that the ownership sold is not visible on the share register, and has to be tracked separately until conversion.

What do the valuation cap, the discount and the most-favoured-nation clause do?

The valuation cap, the discount and the most-favoured-nation clause are the three ways a SAFE rewards an investor for paying before the priced round. Each sets, in a different manner, the price at which the purchase amount turns into shares.

A valuation cap is a ceiling on the valuation used to price the conversion. If the priced round values the company above the cap, the SAFE converts as though the valuation were the cap, so the investor pays less per share than the new investors. If the round comes in below the cap, the standard form gives the investor the round's own price instead, whichever yields more shares.

A discount is a percentage taken off the price the new investors pay. The standard documents express it as a discount rate equal to 100 minus the discount percent, so a 20% discount is written as an 80% rate: the SAFE converts at 80% of the round price, whatever that price turns out to be.

A most-favoured-nation clause, usually shortened to MFN, sets neither a cap nor a discount. It promises that if the company later signs SAFEs on better terms, the holder may amend the earlier SAFE to match them. The guide published with the standard forms adds three limits worth knowing: the clause typically gives one opportunity to amend, the holder cannot pick terms one by one and must take the later SAFE whole apart from the purchase amount, and a side letter given to a later investor does not trigger it. If a priced round arrives before any better SAFE was signed, the MFN holder receives the same preferred stock at the same price as the new investors.

The standard set today contains three versions: a cap with no discount, a discount with no cap, and an MFN with neither. A fourth version combining a cap and a discount was withdrawn from the published set, though negotiated SAFEs with both terms are still written. With both, the investor converts at whichever price is lower.

How is a SAFE converted into shares at a priced round?

A SAFE converts by dividing the purchase amount by a conversion price, and the whole calculation lies in finding that price. With a post-money cap, the price is the cap divided by the company's capitalization immediately before the round, counted with every SAFE included.

Take a company with 8,000,000 founder shares and an option pool of 1,000,000 shares, so 9,000,000 shares before any SAFE. An investor signs a $300,000 SAFE with a $6,000,000 post-money valuation cap. Later the company raises $4,000,000 from new investors at a $16,000,000 pre-money valuation. To keep the arithmetic readable, the example assumes the option pool is not enlarged in the round.

The investor paid about $0.63 a share when the new investors paid about $1.69, which is the cap doing its work. The shares issued to a SAFE holder in that case form their own sub-series of preferred stock, with the same rights as the new investors' shares but a liquidation preference based on the lower price actually paid, so that $300,000 invested carries a $300,000 preference, not more.

A discount-only SAFE runs differently, because nothing is fixed until the round is priced. With a 20% discount on the same $300,000 and the same round, the conversion price is 80% of the round price. The two depend on each other, since the SAFE shares count in the capitalization that sets the round price, and solving both together gives a round price of about $1.7361, a discount price of about $1.3889 and 216,000 shares. Those shares are worth $375,000 at the round price, which is simply $300,000 divided by 0.80. The investor ends with 1.875% of the company after the round.

The table gives the investor's ownership immediately before the new money, across four possible valuations for the round.

The discount beats the cap whenever the round is valued below $7,500,000, which is the $6,000,000 cap divided by 0.80, and the cap wins above it. In the first row the round is priced below the cap, so the cap-only investor takes the round's own price: $300,000 of a $5,000,000 company is 6%.

What is the difference between a pre-money SAFE and a post-money SAFE?

A pre-money SAFE measures its cap before the SAFE money is counted, and a post-money SAFE measures it after all the SAFE money is counted. The post-money form therefore fixes the investor's percentage on the day of signing, while the pre-money form leaves it to shrink with every later SAFE.

The original form of 2013 was pre-money. Its cap applied to a capitalization that left out the shares to be issued to SAFE holders, so the SAFEs diluted one another along with the founders, and nobody could state an investor's percentage until the last SAFE was signed. The post-money form, released in 2018 by the same accelerator, counts all SAFE shares inside the capitalization. In the publisher's words, ownership is measured after all the SAFE money is accounted for, and the main benefit is the ability to calculate immediately and precisely how much of the company has been sold.

Suppose the $300,000 investor above had signed a pre-money SAFE with a $5,700,000 cap, which also comes to 5% if the SAFE stands alone: $300,000 over $5,700,000 plus $300,000. If the company then signs further SAFEs at the same cap until $800,000 is outstanding, the first investor's stake falls to 4.62%. At $2,000,000 outstanding it falls to 3.90%. Under the post-money form the stake stays at 5% in all three cases.

The percentage that the investor keeps is the percentage that someone else gives up. With post-money SAFEs, every new SAFE dilutes only the existing shareholders, in practice the founders and the option pool. The guide to the forms states it directly: SAFEs do not dilute each other, and are diluted later by the new money of the priced round and by any increase of the option pool adopted in that round.

How much do founders give up when several SAFEs stack?

Founders give up the sum of the percentages sold, because each post-money SAFE takes its purchase amount divided by its cap from the existing shareholders alone. Three SAFEs sold at 5%, 5% and 10% remove 20% of the company before the priced round has begun.

Extend the example. The company signs three SAFEs over a year, each at a higher cap than the last, then closes the same $4,000,000 round at a $16,000,000 pre-money valuation.

The 9,000,000 existing shares must now be 80% of the capitalization, which makes it 11,250,000 shares. The round price is $16,000,000 divided by 11,250,000, about $1.4222, and the new investors receive 2,812,500 shares, for 14,062,500 in total. After the round the three SAFE holders own 4%, 4% and 8%, the new investors 20% and the option pool 7.11%.

Notice that the first investor now receives 562,500 shares, not the 473,684 of the single-SAFE case. The percentage is what the post-money cap fixes; the share count adjusts to deliver it. The founders' side of the same ledger is the chart below.

The dilution from SAFEs is settled when each one is signed, not when the round closes. A higher cap on a later SAFE also helps less than it seems when the cheque is larger: the third SAFE has the highest cap in the example and still takes the most, 10%, because it is four times the size of the first.

One assumption deserves a word. Priced rounds often come with a larger option pool, demanded by the new investors and created before their money goes in. Under the standard form that increase is left out of the capitalization used for the SAFE price, so SAFE holders share its dilution with the founders.

What happens to a SAFE if the company is sold or dissolved before it converts?

If the company is sold before a priced round, the holder of a standard SAFE receives the greater of the purchase amount or the amount the SAFE would fetch if converted into common stock at the cap. If the company is dissolved, the holder is entitled to the purchase amount, to the extent money is left.

For the sale, the standard form computes a liquidity price: the cap divided by the capitalization immediately before the sale, this time excluding the unissued part of the option pool. Take the first investor alone, $300,000 at a $6,000,000 cap, and two possible sale prices, ignoring debts, costs and option exercise prices for simplicity.

• A sale for $9,000,000: converted, the SAFE is 5% of the company and worth $450,000. That exceeds $300,000, so the investor takes $450,000 and the other holders share $8,550,000.
• A sale for $4,000,000: converted, the SAFE would be worth $200,000. The investor takes the $300,000 purchase amount instead, and the others share $3,700,000.

The switch happens at a sale price equal to the cap. Below it, the SAFE behaves like a claim for the money back; above it, like a share. The form says so in terms: the SAFE is intended to operate like standard non-participating preferred stock. Its ranking follows from that. The holder's claim is junior to outstanding debt and creditor claims, on par with other SAFEs and with preferred stock, and senior to common stock. If the proceeds do not cover all the claims at that rank, they are shared in proportion.

A dissolution applies the same ranking to whatever the company has left. Creditors are paid first, and a company that winds up with a handful of SAFEs outstanding has usually spent most of the money raised. The right to the purchase amount is real, but it is a right against a nearly empty account. A SAFE ends when shares are issued on conversion or when the amount due on a sale or dissolution is paid or set aside.

What is a pro rata side letter?

A pro rata side letter is a short separate agreement giving a SAFE investor the right to buy shares in the priced round in which the SAFE converts, so as to hold on to the percentage held before the round. The right is not inside the standard post-money SAFE; it exists only if the company signs the letter.

According to the guide to the standard forms, the letter lets the holder subscribe for a percentage of the round equal to the holder's as-converted ownership, and it covers the round in which the SAFE converts, not the rounds after it. In the stacked example, the third investor holds 10% before the round and could therefore buy up to 10% of the $4,000,000, or $400,000, at the round price. Having done so, that investor would hold the 8% from the SAFE plus 2% bought in the round, back to 10%.

For founders, each letter is an allocation promised in advance. New lead investors usually want a set percentage for themselves, and every share reserved for earlier holders must come either out of the lead's allocation or out of additional dilution. That is a reason to grant such rights deliberately, and to record them next to the SAFEs.

What does the SEC's investor bulletin on SAFEs warn about?

The SEC's investor bulletin on SAFEs warns that a SAFE is not common stock, that it may never convert, and that its terms vary from one offering to the next. The bulletin, issued in May 2017 by the SEC's Office of Investor Education and Advocacy, is titled "Be Cautious of SAFEs in Crowdfunding" and addresses individuals buying SAFEs through crowdfunding offerings.

The bulletin makes its points mostly as questions for the investor to put to the document. Its content can be read as five checks.

• Triggering events. A SAFE may convert only if certain events occur, and depending on its terms it may not be triggered at all. A company that never raises another round and is never acquired can leave the holder with nothing.
• Conversion terms. The investor should find out how the valuation at the future financing affects the number of shares received, and whether the amount converts as invested.
• Repurchase rights. Some SAFEs let the company buy back the investor's future right to equity instead of converting it. The bulletin asks whether the investor has any say, and at what price.
• Dissolution rights. The investor should know what happens to the SAFE and to the money invested if the company dissolves.
• Voting rights. SAFEs do not have voting rights similar to common stock, and the bulletin asks whether the holder is given any voice in particular circumstances.

Two further remarks concern context. The SEC notes that SAFEs were developed for fast-growing startups expected to attract venture capital, which may or may not describe a given crowdfunding issuer. The bulletin also states that there is nothing standard or simple about a SAFE across offerings, because companies treat triggers and conversion prices differently.

Is a SAFE a security, and who can buy one?

A SAFE is treated as a security in the United States, so it must be sold either under a registration with the SEC or under an exemption from registration. In practice startups rely on exemptions, and the exemption chosen decides who may invest.

The standard form shows this on its face. It opens with a legend stating that the instrument and any securities issuable under it have not been registered under the Securities Act of 1933 and may not be offered, sold or otherwise transferred except as that Act and state securities laws allow. It then has the investor represent being an accredited investor as defined in Rule 501 of Regulation D, and lets the company void the SAFE and return the purchase amount if the investor turns out not to be accredited at the time of the priced round.

The other route is crowdfunding. The SEC's bulletin recalls that since May 2016 its rules have allowed individual investors to take part in securities-based crowdfunding, and that some of those offerings use SAFEs. Those SAFEs are generally not the standard form, which is why the bulletin insists on reading the terms.

Three practical consequences follow in general terms. A SAFE cannot be freely resold. The company owes its SAFE investors accurate information, as with any sale of securities. And the tax treatment is a separate question: the standard form records the parties' intention to treat the SAFE as stock for specified sections of the United States tax code, a statement of intent that an adviser should confirm for each party's situation. Outside the United States, whether and how the instrument can be used depends on local company and securities law, and the form's publisher itself recommends consulting a lawyer licensed in the country concerned.

How does a SAFE differ from a convertible note?

A SAFE differs from a convertible note in that the note is debt and the SAFE is not. Both convert into shares at a later round using a cap, a discount or both, but only the note carries interest, a maturity date and a legal obligation to repay.

The SEC's bulletin draws the same line: convertible notes are debt and generally represent a current legal obligation of the company to the investor, which a SAFE does not.

The absence of interest and maturity makes the SAFE cheaper to run for the company: the guide to the forms points out that no time or money goes into extending maturity dates or revising interest rates. It also removes the lever a noteholder has when a company drifts for years without a priced round. A matured note gives its holder a say; a SAFE simply waits. Which instrument suits a given financing depends on how certain the next round is, on the investor's need for a fallback, and on what local law allows.

What happens on the day a SAFE converts?

On the day of the priced round, the SAFE disappears and the investor becomes a shareholder, without paying anything further. The money moved once, when the SAFE was signed; conversion is an issue of shares, recorded in the round's documents.

A SAFE of $200,000 with an $8,000,000 post-money cap, for instance, becomes 2.5% of the company immediately before the new money, whatever the share count needed to deliver it. The only payments at closing are those of the new investors, plus any amount a SAFE holder chooses to add under a pro rata side letter.

Before that day, the useful work for a founder is the ledger: each SAFE's purchase amount, cap, discount and side letters, the running total of ownership sold, and a conversion model run at two or three plausible round valuations. For an investor, it is confirming which form, pre-money or post-money, sits behind the cap.