What is a Simple Agreement for Future Equity?
A Simple Agreement for Future Equity (SAFE) is an agreement between a startup company and its investors, in which the company agrees to issue shares of stock at a later date in exchange for cash or other forms of funding.
The SAFE provides investors with an opportunity to gain equity in the startup company while also allowing the founders to retain control over their business. It allows both parties to enter into negotiations quickly and easily, as it does not require complex legal documents or disclosures about financial information.
Additionally, it ensures that both parties are aware of their rights and obligations from the outset so there are no unexpected surprises later on down the line. The SAFE is commonly used during early seed rounds when startups need capital but have not yet established themselves enough to attract venture capital investors who would require more involved agreements with greater legal complexity and financial disclosures than those required by this type of agreement.
What should you consider when signing a Simple Agreement for Future Equity?
How does a simple agreement for future Equity work?
Startup companies (or other companies) and investors enter into an agreement that lays out the terms of their cooperation. There are a number of things they negotiate, such as:
- Valuation caps.
- Investment amount.
- Maturity date/event.
After the terms have been agreed upon and the SAFE has been signed by both parties, the investor sends the company the funds that have been agreed upon by both parties. As far as the terms and conditions are concerned, the company will apply the funds in accordance with the terms and conditions.
It is not until an event listed in the SAFE agreement triggers the conversion of the equity (SAFE preferred stock) that the investor obtains equity (SAFE preferred stock).
As a result, a SAFE that has not matured is treated like any other convertible security (for example, a warrant or an option) that has not matured.
How are safe agreements treated under securities laws?
SAFE agreements can be structured simply and offer preferential rights to investors. They are attractive to experienced investors due to their complexity and preferential rights.
When compared with common stock shareholders, SAFE agreement holders have greater rights. However, the Securities and Exchange Commission (SEC) warns investors about using SAFEs since they may not deliver on promised liquidity events or trigger them at all.
It is important for startups to seek legal counsel when drafting terms and conditions for a SAFE agreement since securities lawyers have a strong command of finance law and experience working with startups.
What is a Y Combinator?
Y Combinator is a Silicon Valley-based startup accelerator that provides funding, mentorship, and networking opportunities to entrepreneurs. It created the Simple Agreement for Future Equity (SAFE) in 2013 as an alternative to convertible notes. The SAFE allows startups to raise funds while retaining more control over their company than they would with a traditional convertible note.
Signing a SAFE is beneficial for startups because it offers more flexibility than traditional convertible notes. For example, startups can specify what type of equity they are offering in exchange for funds raised via the SAFE (e.g., common stock or preferred stock).
They also have greater control over when investors can convert their shares into voting rights or liquidation preferences – this feature allows them to delay investors’ ability to influence major decisions until later stages of growth when it makes sense for both parties involved.
What is the value of equity?
The value of equity in a Simple Agreement for Future Equity (SAFE) is dependent on the valuation cap set by the investor. Without a valuation cap, the percentage of the equity to be awarded to the SAFE investor decreases as company value increases.
For example, an investor may choose to invest $50,000 with a valuation cap of $1 million to get five percent of the company. If there is no valuation cap in place, then this percentage would decrease if the company value skyrocketed to $5 million. The exact numbers are subject to some nuances related to future equity investments which will be explored in a future blog post.
Who will own the equity?
When signing a Simple Agreement for Future Equity, the investor will typically own the equity. This is because it is an agreement for future equity and represents an obligation to provide shares in exchange for funding or services in the future. The investor will generally have rights to any equity that is issued as part of this agreement.
When will the equity be issued?
The equity will be issued once the conditions specified in the SAFE are met, typically when the company reaches a certain stage of development or achieves certain milestones. The parties may also agree to issue the equity sooner, depending on their discretion.
What is the form of equity?
The form of equity in a Simple Agreement for Future Equity (SAFE) is typically common stock or preferred stock.
Common stock is simply shares of ownership in a company that entitles the holder to vote on major decisions and receive dividends if declared by the board of directors. Preferred stock gives holders special rights, such as priority when it comes to receiving dividends or liquidation proceeds from the company. Both types of equity can be exchanged for cash when needed, unlike non-dilutable options such as convertible notes.
WHO SHOULD YOU CONTACT TO LEARN MORE
There is a lot to be gained by signing SAFE agreements. However, what can be beneficial to a startup, such as the absence of standardization, can also be detrimental if the agreement is not properly drafted and negotiated in a professional and strategic manner. Contact Free Cash Flow today if you are a startup looking for alternative and creative ways to find investors and you want to find them as soon as possible.