A Crash Course on SAFEs

Here are some important things to keep in mind if you are considering raising capital in a SAFE round.

What’s the Difference Between a SAFE Financing and a “Priced Round?”

When raising capital, one of the main considerations is whether to (a) use a convertible security, like a SAFE or a convertible note, or (b) issue preferred stock at a fixed valuation. If you want to avoid having to negotiate a fixed valuation and you want to close more quickly and for less cost, a convertible security is preferable. On the other hand, the greater the amount of funds raised in the financing, the more likely it will be a priced preferred stock financing. This is especially true if the round involves institutional VC investors, as they will typically require the investor rights and preferences that are associated with priced rounds when making substantial investments. For further discussion, please read this blog post.

What’s the Difference Between a SAFE and a Convertible Note?

Once you’ve made the decision to use a convertible security, you must choose between a SAFE and a convertible note, which are similar but different. A SAFE doesn’t have a maturity date or an interest rate, and may involve slightly less documentation than a convertible note. However, convertible notes are more customizable than SAFEs, and some investors may not be comfortable using SAFEs because they hypothetically afford less downside protection. For more on this, please read this blog post.

What Is a SAFE and How Does It Work?

A SAFE is a “simple agreement for future equity,” that is, is a promise by a company to issue equity in the future in exchange for a cash investment by an investor. The SAFE automatically “converts” into shares of preferred stock sold in a future equity financing (which is typically in the form of a separate “shadow series” of preferred stock – see this post for more about shadow preferred stock). The amount of equity that the investor receives in such future equity financing depends on the type of SAFE (see next section). The SAFE also converts into cash or equity if the company is sold or dissolves before an equity financing occurs.

What Are the Types of SAFE and How Are They Different?

There are four main types of SAFE: (1) valuation cap, (2) discount, (3) valuation cap + discount, and (4) most favored nation (MFN). They are defined by how you calculate the amount of equity received by the SAFE holder(s) upon conversion. The SAFE holders’ investment amount is divided by the “SAFE price” to determine how many shares of preferred stock the SAFE holder(s) receive upon conversion. The SAFE price for each type of SAFE is calculated as follows:

  • Valuation Cap: SAFE Price = Valuation Cap / Company Capitalization
  • Discount: SAFE Price = next round price * (100% – discount)
  • Valuation Cap + Discount: Whichever of the above calculations results in more shares of preferred stock
  • MFN: Converts at next round price, unless someone else gets a “better deal,” in which case it converts at whatever that better deal is

What Is the Difference Between “Pre-Money” and “Post-Money” Valuation Cap SAFEs?

The difference is how you calculate the “company capitalization”—the denominator in the above calculation of the SAFE price—at the time the SAFE converts. While the most common SAFEs in the marketplace are “post-money” (including, for example, the Y Combinator forms of valuation cap SAFEs), we generally recommend using pre-money SAFEs because they can be far less dilutive to founders. For further explanation, please read this blog post.

How Are the Perkins Coie Forms Different From Other SAFEs in the Market?

Primarily, our forms are “pre-money” documents that incorporate many of the noneconomic improvements released in Y Combinator’s post-money forms. Also, we have developed a comparison chart to identify the differences in detail. If you would like a copy of the chart, please contact a Perkins attorney and we’d be happy to share and discuss it with you.

Steps to Closing

Once you’ve decided to do a SAFE round, here are the basic steps to getting the money in the door:

  • Shopping the Terms: You may want to shop the SAFE terms to investors before going any further. Investors may have thoughts about the type of SAFE, valuation caps, discounts, and other things like pro rata rights and management rights. Obtaining feedback from multiple investors before committing to terms can be quite helpful. Plus, it’s ideal to have all investors on the same set of terms (rather than doing one-off deals as you go). If they are on different terms, the future equity round will be more complicated and expensive.
  • Board of Directors Approval: Once you settle on the SAFE terms, the Board of Directors must approve the form of SAFE and the aggregate dollar amount of the round. The Board should approve a raise large enough to avoid having to consider an increase later, but not so big that you’re unable to fill out the whole round. That way you can set realistic expectations and deliver.
  • Important! Securities Laws: SAFEs, like convertible notes and company stock, are securities of the company, and the offer and sale of securities must be made in compliance with applicable federal and state securities laws. Securities compliance involves a lot of important considerations and traps, but the main takeaways are: (1) offer and sell securities only to “accredited investors,” (2) avoid crowdfunding, any publicity, or widely distributed communications about your fundraising, and (3) tell your counsel immediately when you have commitments from investors because they need time to do research and apply for securities laws exemptions on your behalf, which should happen before you accept investor funds. As part of the securities compliance process, you will need to sign various other documents (e.g., Form D, “Bad Actor” Questionnaires, and other state filings), on which your counsel will follow up as you get closer to closing.
  • Closing Process: After you have firm commitments from investors and the Board has approved the round and form of SAFE:
    • Each investor signs the SAFE;
    • Investors send funds;
    • Company confirms receipt of funds and sends proof of payment to counsel; and
    • Company countersigns the SAFE and sends fully signed copy to each investor and counsel.

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.