Startups often rely on venture capitalists or angel investors to help them embark on the big journey. However, when an investor invests a substantial sum in your company, they expect some security and return on their investment. Traditionally, investors will ask for a part of your company’s equity. However, entrepreneurs are shifting to a new arrangement with investors through Simple Agreement for Future Equity (SAFE).
For every startup owner who wishes to implement SAFEs with their investors, the first step is to learn everything about them. So today, we will be discussing precisely what a Simple Agreement for Future Equity (SAFE) is, how it works, and if it’s worth it.
What Is a Simple Agreement for Future Equity or SAFE?
A SAFE or a Simple Agreement for Future Equity is a convertible note which acts as an agreement between your company and an investor. Here, the latter is given the right to get new shares of your company in the future in return for their cash investment.
What makes SAFEs different from traditional investing is the investor will not ask for a share in your company or its stocks right when they start supporting you. However, in the future, when there is “equity financing,” a “liquidity event,” or “a dissolution event,” the investor can demand their share(s) of the company. SAFEs also do not have any maturity date, and you do not incur any interest for this investment.
How Does a SAFE Work?
The most significant advantage of SAFEs is their ease of execution. Once you have narrowed down upon an investor, these are the few things that need to be discussed with them:
- Valuation Caps: Valuation caps help your investor get a better price for your company’s shares. Under this, if you raise funds at a valuation above the pre-decided “cap,” your investor can convert his investment to equity at a price equivalent to the cap.
- Discounts (if any): Your agreement might also offer the investor a discount on the share price when converting the safe into equity. For example, if a share costs $100 and you offer a discount of 30%, your investor will be able to buy your company’s shares at $60 in the future.
- Terms of the Agreement: Although all SAFEs have common rules, the terms and conditions that will govern your SAFE agreement with a potential investor may vary slightly. It is important to go through the agreement properly to understand how well you will benefit from it.
- Investment amount: The investment amount simply refers to the investor’s willingness to invest in your company under SAFE.
Once these clauses are discussed, the contract will be signed, and the investor will transfer you the pre-decided amount. However, depending on the terms and conditions of the agreement, you might have to invest the grant in the ways the investor in the contract has mentioned.
In this case, the investor does not directly qualify to get your company’s shares. However, when an event is mentioned in the contract, your investor will have the right to discuss their shares as equity financing occurs. Until an event triggers the conversion of SAFE to equity, it will be treated like any usual convertible security like warrants.
Why are SAFEs Beneficial For Startups?
The biggest question that every startup owner would have is if a SAFE is worth it and if they at all bring any value to the table. So here are a few reasons why SAFE is worth it, especially for startups:
1. No Risk of Debt
Your startup is just beginning its journey and striving to spread its roots in a fiercely competitive market. In this scenario, although you need financial assistance, incurring debt might not be the correct answer. The burden of a debt not only slims down the success probability of the company but in case the venture fails, you will be burdened with the responsibility to pay back the investor.
However, SAFEs don’t impose any such responsibility on you. Under this arrangement, the investor only reaps benefits alongside your company if and when it grows.
2. No Interest Payout
The downsides of taking out a loan are not just about the burden of having to pay it back. One of the most significant disadvantages of debt is the high interest rates it brings along. When your business is just starting, you need to spend every penny judiciously to survive in the long run. In this scenario, high interest rates will add to your financial burden and hamper your company’s profits.
However, SAFEs are entirely interest-free. So you neither have to worry about clearing debts nor spending extra on interest.
3. Lower Legal Costs
Like any company, your startup also requires legal representatives to ensure that you abide by the law of the land. Even for negotiations and agreements, it’s always recommended that you have a legal team representing your party.
However, legal costs are one of the highest overhead expenses for companies, and startups certainly cannot afford to spend mindlessly. In such a scenario, a Simple Agreement for Future Equity is relatively easy to create and execute.
It requires less paperwork and effort from the legal team, which reduces the legal costs and helps you close the deal at a cheaper cost.
4. Not Having To Give Up Control
Under traditional investment arrangements, you would have to transfer a certain percentage of the stocks to the investor. However, when the investor gains stocks in a company, they also gain a certain degree of power, voting rights, and a say in significant decisions of the organization.
However, you might want to keep the rights to yourself until your vision for the company is met. In a situation like this, SAFEs are the best way out for startup owners. You get the required funding for your business without parting with any percentage of company rights immediately.
5. No Fixed Maturity Date
Convertible notes are a common debt instrument, but the biggest disadvantage is their fixed maturity date. By the pre-decided date, you either have to return the entire investment amount or convert it to equity.
However, with SAFE, you only have to convert the investment to equity when a future financing event triggers the conversion. So you do not have to worry about paying back, and sometimes you might never have to convert the investment to equity. Although the chances of this happening are slim, if your company never has to raise funds or is never acquired, the SAFE with your investor will never be triggered.
Every startup needs a little financial boost in its initial days to scale its businesses. With higher flexibility and lower risks, SAFEs offer budding startups a convenient and comprehensive financing solution.
So, let the experts handle it if you need help with launching a Simple Agreement for Future Equity or SAFE for your company to raise funds from investors. Get in touch with us today!