Simple Agreements for Future Equity – a Primer
Alykhan Sunderji discusses Simple Agreements for Future Equity (“SAFEs”) with the Chicago Daily Herald in a recent finance article. Alykhan Sunderji gave his insights on the utility of SAFE notes, including the benefits early stage investors can gain from holding a SAFE note. Sunder Legal and its attorneys have broad experience working with startups to raise this kind of financing.
Learn more about SAFE notes by reading the entire article here.
What is a SAFE?
SAFEs are designed to be a simple way for startup companies to secure financing in amounts less than $1mm. It is considered the first step in venture financing, immediately before Series Seed and sometimes Series A. In a nutshell, they are an agreement to give a startup cash today, and in the future when the company raises more money in a “priced round,” that cash will convert into equity in the company. The price paid by the SAFE investor will be at a discount to what the future investors pay. This is their pay off for investing in the startup before the startup has a clearly defined value..
How else is it simple?
Most SAFEs are based on the Y-combinator form found here. There are a few key terms negotiated over – the discount, the valuation cap, and the term.
What are the discount and valuation cap?
An investor is taking a risk by investing in a company that technically has no valuation. They are betting the startup takes their $250-500k and creates a $5-10 million dollar company. Their pay off is that they will get a discount when new funds are raised, locking in their appreciation. The investor typically negotiates for a discount, a cap, or both. If they negotiate for both, the equity converts using the most favorable formula.
A discount is exactly what it sounds like. If a new investor values a new company at $10 million and there is 20% discount, the equity will convert as if the startup was only worth $8 million. This means the investor receives a 20% discount. Using share prices instead – if the startup is worth $10 million and has $10 million shares outstanding, that means each share is worth $1. The new investor will pay $1 a share for each new share, but the SAFE investor will only pay 80 cents.
A valuation cap is another way of securing a discount. Let’s say the valuation cap is $7 million. That means no matter the valuation, the maximum deemed valuation for the SAFE investor is $7 million. If a startup raises new money at a $20 million valuation, each share is $2. The SAFE investor will only pay 70 cents.
What are SAFEs used for?
SAFES are used for early stage companies. They typically have a pro-type or some traction and need an investment to get to the next level. Investors tend to be angel investors or friends and family.
Do I need a lawyer for this?
It is very common for investors to send out non-standard term sheets, even to sophisticated startup founders. Attorneys can also help you decide what kind of information to share, how to define your pitch, and make sure your corporate records are in order. Many companies that issue SAFEs may have already promised equity to employees, and a good startup attorney will help you document all these equity arrangements. Once a startup is at this stage, there are a number of clean up items a firm like Sunder Legal can help with.
Sunder Legal – A Seattle Based Law Firm
Sunder Legal works with startups and new businesses to raise financing and negotiating their most important contracts. Sunder legal is a business law firm proudly located in Seattle, Washington. To set up a meeting , Contact Us. You can call or easily schedule an appointment.