What is a SAFE in Finance? A Beginner’s Guide

Let’s start with a simple question: what is SAFE in finance? A SAFE, or Simple Agreement for Future Equity is widely used in the startup world. For someone interested in investing in early-stage companies, SAFE assets in finance are vital and shouldn’t be ignored. They’re similar to a handshake agreement with some legal teeth to it. No hassle. No immediate ownership transfers. But, a promise for the future.

This blog will break it all down for you. We’ll explore how the Simple Agreement for Future Equity works, why it matters, its benefits and risks, and how it fits into the broader world of early-stage investing. Ready? Let’s dive in.

How SAFEs Work?

A SAFE is a legal agreement between a startup and an investor. It’s a promise: the investor gives money now, and in return, they get equity later—usually during the startup’s next priced funding round.

What is a patent, if not a foundation for future innovation and growth? Similarly, investing in a company at its early stages is like planting the seeds of potential success. The terms of such investments in a SAFE are often structured using mechanisms like valuation caps and discounts, designed to reward investors for their early risk-taking. These features ensure that early supporters get rewarded when the company grows. 

Here’s a quick breakdown of how it works:

• The investor puts money into a startup using a SAFE
• The startup gets to use that money immediately without issuing shares at this time 
• At a future priced funding round, the investor’s SAFE converts into equity—the investor now gets shares in the company.

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Simple, right? But don’t let the simplicity fool you. Simple Agreement for Future Equity (SAFE) can be incredibly useful tools when used correctly. They allow startups to raise funds quickly without getting bogged down by the complexities of traditional equity financing.

Benefits of a SAFE

SAFE assets in finance are as effective as traditional funding rounds with the proper employment. They enable startups to attract funds without the concern of the formality of the more complex and costly equity financing method. Let’s explore.

Benefits for Startups

1. Speed and Simplicity: SAFE assets in finance are easier to execute compared to equity funding. The legal formalities are minimal, and the cost is considerably reduced. For a founder who has many things to attend to, this timesaving cannot be over-emphasized.

2. Flexibility: Unlike traditional priced funding rounds, a startup does not need to set a fixed price or valuation at the time of negotiating and signing a SAFE. This flexibility is particularly beneficial in the early stages of building your company, especially if you have not yet achieved product-market fit.

3. Cash Flow without Immediate Dilution: Simple Agreement for Future Equity (SAFE) allows founders to avoid high dilution early on by delaying the issuing of shares to investors. This means they delay losing control over their company to the outside world.

4. Investor Alignment: SAFEs sometimes contain features like valuation caps which help establish the maximum valuation the SAFE will convert at in a future financing round, even if the valuation at that time is higher than the cap listed in the SAFE. 

Benefits for Investors

1. Access to High-Growth Startups: SAFE assets in finance enable the investors to get into a startup at an early stage with hopes of it becoming a success in the future. For those who can spot and invest in a promising startup, this can lead to big rewards in the future.

2. Upside Potential: It gives early investors a better deal when SAFEs convert to equity because of provisions such as valuation caps and discounts. This ensures investors' early risk-taking is rewarded.

3. Streamlined Process: Simple Agreement for Future Equity (SAFE) is easy to manage and enables investors to invest quickly without concerns about lengthy legal processes. And, it enables startups to access capital faster.

4. Reduced Negotiation Time: As for the investors, SAFEs save time on negotiations of the terms and valuations. They are also much faster to close compared to traditional priced rounds with more complex documentation. This is especially attractive when investing in multiple startups because less time is needed when finalising the terms.

Risks and Considerations of SAFEs

Yet, there are some hurdles to overcome. SAFEs come with risks—for both startups and investors.

1. Uncertain Outcomes: SAFE assets in finance only convert into equity if a certain trigger event (like a priced funding round) occurs. If the company never raises more funds, the SAFE might not convert, leaving investors in limbo.

2. Lack of Investor Protections: SAFEs don’t give investors voting rights or dividends in most cases—at least not until they convert into equity. This can be frustrating for those who want a say in the company’s decisions.

3. Cap Table Complexity: For startups, too many SAFEs can create a messy cap table, making future fundraising more complicated. A cluttered cap table can deter potential investors in later rounds.

4. No Guarantees: Investors could lose their entire investment if the startup fails before the SAFE converts. As with any early-stage investment, there are no guarantees.

5. Limited Liquidity: Simple Agreement for Future Equity (SAFE) is not a liquid asset. Investors must wait for a trigger event to realize their returns. This lack of liquidity can be a drawback for those seeking quicker financial returns.

SAFEs vs. Other Early-Round Financing Instruments

How do SAFEs stack up against other options, like convertible notes or equity rounds?

Convertible Notes: These are similar to SAFEs, but act as debt. They accrue interest and have a maturity date, unlike SAFEs, which don’t carry interest. This added complexity can make convertible notes less appealing. Today, SAFEs are more popular than convertible notes.

Equity Rounds: In a traditional equity round, investors get immediate ownership of the company. While this provides more certainty, it’s also more complex and costly for startups. Legal fees and extended timelines can slow down the fundraising process.

Grants and Revenue-Based Financing: These alternatives don’t dilute the startup's equity but often come with restrictions or repayment terms. Simple Agreement for Future Equity (SAFE) is more flexible by comparison, offering startups breathing room to innovate and find product-market-fit.

In short, SAFE assets in finance offer simplicity and flexibility. But they’re not a one-size-fits-all solution. Investors and founders should evaluate their specific needs before choosing what is best for them.

Legal and Regulatory Considerations of SAFEs

SAFEs are simple structures, however, they are not immune to legal and regulatory requirements.

1. Compliance with Securities Laws: For this reason, SAFEs are regarded as securities, which means they need to conform to the rules of such authorities as the SEC. Startups must ensure they comply with regulations to avoid facing penalties.

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2. Clear Documentation: Ideally, startups should ask for legal assistance when drafting the SAFE agreements to avoid common pitfalls with investors. This is an important point as it will help to avoid ambiguity that can create disputes down the line around terms that will not stand up to scrutiny.

3. Tax Implications: Consequently, the issuance of Simple Agreement for Future Equity (SAFE) can bear tax implications for startups as well as investors. More on that in the blog later on. 

4. Jurisdictional Differences: When using a SAFE, make sure that it follows the legal requirements in your country and jurisdiction. It is highly recommended that you seek legal counsel and advice from an expert who practices law in your state or country.

What is the Valuation Cap in a SAFE?

A Simple Agreement for Future Equity (SAFE) often carries a valuation cap that lists how much it will be valued upon conversion to equity. Look at it as a reward that goes to the first movers. Even if the priced funding round is sometime in the future, the SAFE holder gets equity at a better rate than the new investors.

For instance, if you invested at a $5 million cap and the company is later valued at $10 million, you will convert at the lower $5 million cap. That’s the big upside. 

Valuation caps do more than encourage early investment; they also create mutual interest between investors and founders as they don’t have to agree on a valuation at the time signing the SAFE. This is part of what makes SAFEs so appealing.

Pre-money and post-money SAFE: What’s the Difference?

Pre-money and post-money SAFE assets in finance differ in how they calculate the company’s valuation:

Pre-Money SAFEs: The valuation cap does not yet take into account the investment from the current SAFE round. This can be a problem when calculating the dilution of other shareholders.

Post-Money SAFEs: The valuation cap comprises the current Simple Agreement for Future Equity (SAFE) investment. It provides investors with a better understanding of their ownership percentage.

It is only a matter of recent years that the posy-money SAFEs have emerged as standard practice. It is more accurate for investors because they are less speculative and obscure when it comes to ownership percentage.

Pre-money SAFEs may be more beneficial to startups that are launching later rounds of fundraising, while post-money SAFEs could be helpful to startups that are going to launch the initial round of fundraising.

How is a SAFE Taxed?

The issue of taxation of SAFE assets in finance is sometimes complex. Here’s what to know:

1. For Investors: The income tax law has it that SAFEs are not subject to taxation if they remain in their state, or if they provide a financial benefit such as a sale. 

2. For Startups: The money that is created through the use of Simple Agreement for Future Equity (SAFE) will eventually convert to equity. This might be seen as a liability until the SAFE converts. To avoid putting early pressure on startups by way of taxation, this is one of the benefits..

3. Potential Gains: If and when SAFEs convert, investors will eventually incur capital gains taxes but only when they sell their equity. It is reviewed and depends on the period over which the SAFE was obtained and the legislation of the country.

In every case, it is advisable to seek help from a tax expert. SAFEs work in not always a straightforward way when it comes to taxation, and the legislation can be quite different from one country to another.

Can a SAFE Be Used At a Later Funding Round?

SAFEs can be used in later rounds even though they are intended for use in angel and seed capital fundraising. However, there are caveats:

1. Investor Appetite: For later-stage investors, equity or even convertible notes may be the preferred instruments to hold. These investment structures are often seen as more favorable compared to Simple Agreement for Future Equity (SAFE) arrangements, which might appear less appealing to seasoned investors.

2. Cap Table Complexity: When employing SAFEs in different rounds, ownership status becomes more complex and it is difficult to attract other investors, particularly if they are stacked on top of each other.

3. Strategic Use: Interim funding can be provided through SAFE structures, but they should be used sparingly between large rounds, as they can cause over-dilution.

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Picking up the Simple Agreement for Future Equity (SAFE) beyond the angel and seed stage should be done cautiously since the above-discussed benefits may not be there at later stages.

How Does a SAFE Impact a Startup’s Cap Table?

SAFE assets in finance can complicate a startup’s cap table. Here’s why:

Deferred Ownership: SAFEs don’t show up as equity until they convert, making it tricky to calculate ownership percentages.

Multiple SAFEs: If a startup issues SAFEs with different terms, it can create confusion during future fundraising rounds.

Transparency Issues: Founders must communicate Simple Agreement for Future Equity (SAFE) terms to avoid surprises for future investors.

The solution? Clear, consistent documentation and careful planning. And, help from your legal counsel.

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Why is SAFE a Safety Asset in Finance?

While SAFEs may sound sophisticated and reassuring, they are not entirely risk-free. However, they remain relatively "safe" in the sense that they are straightforward and align well with the growth patterns of startups. Unlike complex, maze-like securities that can add layers of difficulty, the Simple Agreement for Future Equity (SAFE) was specifically created to offer a simpler alternative to more intricate financing structures. SAFEs also promote early-stage innovation by making funding more accessible and easier to arrange, fostering growth at a critical time in a startup’s journey.

Conclusion

The Simple Agreement for Future Equity (SAFE) is a straightforward and versatile funding tool, especially beneficial for early-stage startups seeking capital. Its simplicity, flexibility, and appeal to investors have made it a favorite among startups and angel investors alike. However, while its advantages are clear, SAFEs are not without risks.

We hope this blog has provided you with a comprehensive understanding of what is SAFE, how they work, their benefits, potential drawbacks, and other key details to help you navigate this financing option effectively.

If you are interested in learning more about angel investment there are a number of ways to level up. Angel School’s Venture Fundamentals program is aimed at teaching you how to invest in promising startups successfully. Get insights on how to assess opportunities and structure SAFEs as well as manage a portfolio of startups effectively. Educate yourself today and be ready for the future!