Welcome to the first installment of our series of posts about Simple Agreements for Equity (SAFEs). As a business owner in search of funding, you’ve likely encountered these agreements that are pitched as “simple” but leave many people confused. In this article, we’ll provide a high-level overview of SAFE agreements, shedding light on their purpose and key uses. We’ll also share some essential tips to help you navigate the intricacies of SAFE agreements and avoid common pitfalls. So, let’s dive in!
What is a SAFE?
A SAFE is a contractual arrangement where an investor provides cash to a company in exchange for the promise of shares in the future. The conversion of the money into shares will normally be triggered by the company raising a priced equity round (which does not include the further issue of SAFEs or convertible notes which are not “priced”). This is known as a Qualifying Round. The number of shares the investor gets is normally calculated by dividing their investment amount by whichever gives the lowest price per share out of the following:
- a discount to the price per share of the Qualifying Round; and
- the valuation cap price,
(meaning you use the price per share which gives the investor the most number of shares).
When are they used?
SAFEs are used:
- when there are uncertainties surrounding company valuations, and the company or investors want to defer a priced round;
- when a company requires funding to keep them going before a larger funding round (known as a bridging round); and
- for seed or pre-seed stage companies, as SAFEs offer a swift and uncomplicated method to secure funds, eliminating the need for negotiating valuations or shareholders’ agreements (although, this is a bit of a red herring as you still need to negotiate the valuation cap!).
Key Terms
To grasp SAFEs fully, it’s crucial to familiarize yourself with the key terms:
Valuation Cap – most SAFEs in the Australian market include a valuation cap. This cap ensures that if the Qualifying Round has a higher valuation than the valuation cap, the SAFE converts at the valuation cap. Essentially, SAFE investors receive more shares for the same amount of money compared to investors in the priced round. The valuation cap can be expressed as pre-money or post-money, a topic we’ll delve into in a later post.
Discount Rate – the discount rate refers to the reduction in the share price that SAFE investors receive on the Qualifying Round. Typically, this discount is around 20%, but it can vary between no discount and up to 50%.
| Top tip on discounts: often the drafting in the SAFE means if you intend the discount to be 20%, in the Schedule to the SAFE where you fill in the discount, you should put 80% as the language in the SAFE will say the discounted price is the share price multiplied by the discount. If your share price is $6 and you multiply by 20% ($1.20), you end giving investors an 80% discount! |
| Example of the Discount vs Cap: an investor invests $500,000 via a SAFE with a valuation cap of $5,000,000. The company raises a priced equity round at a $8,000,000 pre-money valuation (assuming 1,000,000 shares on issue before the round): Valuation Cap Price: = 5,000,000/1,000,000 = $5 per share, and so for the investor’s $1,000,000 they will receive 200,000 shares. Discount Price: 8,000,000/1,000,000 x 0.8 = $6.4 per share for the round, so for the investor’s $1,000,000, they will receive 156,250 shares. You can see here the investor is better off converting using the valuation cap. |
Maturity Date – a maturity date is a date on which the SAFE automatically converts if it hasn’t previously (normally because there hasn’t been a Qualifying Round). This may be at the SAFE price or a discount to the SAFE price – a point to be negotiated! Not all SAFEs contain this provision.
Side Letter – Investors often request a side letter, which outlines additional rights allowing them to subscribe for a portion of the company’s next funding round. When reviewing such letters, it’s crucial to ensure that these rights are not overly restrictive and do not hinder your ability to raise future rounds.
Most favoured nations clause – Some investors may insist on including a most favored nations clause (MFN) in the SAFE. This clause grants the investor the right to demand amendments to their SAFE if you enter into another SAFE with more favorable terms. It’s essential to carefully consider the scope of this clause to prevent future complications if it is overly broad.
If you have any questions about SAFEs, please feel free to book in a free initial call with Kate to discuss:
