SAFE?

A SAFE (Simple Agreement for Future Equity) is an alternative instrument used by startups to raise capital. Introduced by Y Combinator in 2013, SAFEs provide an alternative to traditional convertible notes or equity. Increasingly, we are seeing capital raising in NZ via SAFE instruments. This is understandable as conventional thought suggests a SAFE is a ‘founder friendly’ mechanism.

Key Aspects of a SAFE

• Conversion: SAFEs convert into equity during a future priced round of funding. Investors receive shares based on the valuation of the next funding round.
• No Maturity Date: Unlike convertible notes, SAFEs do not have an expiration date or interest rate.
• Valuation Cap and Discount: SAFEs often include a valuation cap, setting the maximum price at which the SAFE converts, and a discount, offering a reduced share price to early investors to compensate for the extra risk they take by contributing capital early in a company’s life cycle.

Is a SAFE, really safe?

With no interest or maturity date, SAFEs reduce pressure on founders. The SAFE is also intended to provide a balanced and elegant solution to the uncertainty of early stage valuation.

However, there are some commercial, practical and legal pitfalls to be aware of:

• The lack of a maturity date can be risky for investors if the startup delays future funding rounds.
• Because an investor is not issued shares, the investor has no formal role in the company or recognition on the company’s cap table. The investor relies on the Founders and future investors to abide by the terms of the SAFE.
• Legal: A SAFE is neither debt or equity. It creates a legal obligation on the company to issue shares on a future trigger. With limited legal precedent (certainly in NZ), there is uncertainty over the position of SAFE investors if a company defaults or becomes insolvent. There is also possible uncertainty over the tax treatment of a SAFE investment.

To consider from an investor’s perspective

While a SAFE is marketed as a simple and quick path to investment, my suspicion is that if things go wrong, it may prove to be anything but. In my view, ordinary shares or preference shares remain the best and simplest way to invest in a start-up. Sure, valuation is tricky and inexact, but we all know that if a company is successful – the seed valuation is unlikely to be material to the returns on offer.

 

If you need assistance preparing a SAFE, or any other Start-Up law advice, Richard Hoare is here to provide qualified advice.