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SAFE Note Discount Rate

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SAFE note discount rate is the price per share paid by investors new to the equity financing sector, where the discount rates vary from the range of 5% to 30%. SAFE note discount rate is a term that represents savings over what new investors in the equity financing sector would have paid per share. This prevalent concept was curated to help seed development investors and startup companies raise money swiftly and easily. Almost all Y combinator firms have utilized SAFE for early-stage fundraising. Discounts on future converted equity are occasionally applied by SAFEs, often ranging between 10% and 30%. As a result, the investor can buy shares at a reduced price on the subsequent financing. Let us learn more about SAFE note discount rates in this blog below.

Essential Components of SAFE Note Discount Rate

SAFE, which has a discount rate ranging from 5% to 30%, offers a method to raise money comparatively quickly, offering an effective and useful answer in funding periods that typically lack predictability. Mentioned below are essential components of SAFE note discount rate:

  • Valuation Cap: An essential SAFE feature, the valuation cap, aids in determining the highest price at which the SAFE purchase amount, which is the sum invested by the SAFE investor that will be converted into priced round shares. Like a discount rate, a valuation limit protects investors from a valuation increase and allows them to purchase shares at a discount to future buyers.
  • Pro Rata Side Letter: Pro rata side letter is an important component of SAFE. It is not required and should be properly considered to adhere to securities legislation. It is a further benefit that the founders may provide to potential investors. Investors receive proportional rights and contribute to the next round of financing.

Discount vs. CAP in SAFE Note Discount Rate

  • The ideal solution for the founders is for the SAFE to remain uncapped and discounted. It avoids the challenge of assigning any arbitrary value to the enterprise, which may be either too high or too low.
  • Some investors remain adamant about investing in SAFE, which has a valuation cap. The outcome mostly depends on the parties involved and their bargaining power. If the pre-seed stage is considered, uncapped SAFE would suggest that the company has certain leverage on the negotiations, which would help bring in better investors for further rounds of equity financing.
  • All startups in their early stages do not have investors ready to invest. When negotiating a valuation cap, the founders should ensure it has a higher aim to achieve.
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Impact of Valuation Cap and Safe Note on Discount Rate

  • The cap is a maximum on the valuation in the following round, whereas the discount is a percentage off in that round. Early investors will not get a discount and extra shares if the cap is surpassed in the subsequent round. A maximum of $7 million and a 20% discount are given to either invention. Founders should not cap their SAFE without considering further rounds. The SAFE entrepreneurs ought to be compensated for their early investment, given that they are taking a risk by investing in the business at a time of more volatility. However, it is fair not to want them to be purchased at a discount to the prospective investors. If the cap is set too low, owners risk diluting themselves by giving the SAFE investors a great deal of equity.
  • In typical equity transactions, the discount rate, which is 5% to 30%, is frequently referred to as a "bonus rate" for investors who took a risk by investing in a company considerably sooner than other investors. For instance, if a SAFE or convertible note investor provides the business $1 million, the SAFE or convertible note specifies that the interest rate will be subject to a 50% discount. In a typical equity offering, the SAFE or convertible note would, thus, convert into company shares at a 50% discount to the price paid by other investors.

Advantages of SAFE Note Discount Rate for Startups

  • Maturity Rate: SAFEs with a discount rate of 5% to 30% exclude convertible note attributes like payments of interest and deadlines for repayment that offer startup entrepreneurs problems. Through SAFEs, it helps creators reduce their stress about gauging interest or impending maturity dates and asking shareholders for expansions. As a result, founders may focus more on expanding the company.
  • No Requirement to Return Initial Investment: SAFEs are founder-friendly and do not need the investors to return their initial investment if the SAFE does not develop into an investment. Although this is sometimes adversely viewed because those who invest might have nothing, most seasoned seed-stage entrepreneurs know the dangers of investing in fledgling businesses. However, SAFE is inappropriate for investors anticipating receiving their money back if their investment fails.
  • Funding Round: A complex round of funding requires a lot of coordination and writing the money on a close date. With the help of SAFE, the startups can wrap up with the investing party as soon as both parties are ready to sign the agreement and the investor agrees to wire the money.
  • Simple Negotiation: The SAFE published on the Y combinator website is mostly around six pages. They have few variables to negotiate, and it also saves the associated costs related to the transaction.

Key Terms for SAFE Note Discount Rate

  • Safe Note: A safe note is a financial instrument used in early-stage startup financing that enables investors to contribute money in return for the chance to purchase a firm's shares in the future, generally during a later fundraising round.
  • Discount Rate: The proportion by which the investor in a safe note obtains a discount on the share price relative to the price paid by the investors in the next funding round is known as the discount rate.
  • Conversion: Conversion is a process by which an investment in a safe note is converted into business equity shares.
  • Capped SAFE Note: A capped SAFE note has a cap on its valuation following its conversion to equity. This gives investors a glimpse into how many shares they might expect to own.
  • Uncapped SAFE Note: A discount is the only factor affecting SAFE's conversion price without a cap. In other words, an investor always converts at a discount to the following round price regardless of how much the company's value changes.
  • Pre-Money and Post-Money Valuations: Pre-money valuations relate to a firm's worth before adding new capital, while post-money valuations refer to the company's value after adding new capital. The conversion price and the impact of the discount rate on the safe note are determined in part by these values.

Final Thoughts on SAFE Note Discount Rate

The SAFE note discount rate lies between 5% to 30%. A 20% discount is written as 80%, and a 10% discount is written as 90%. Some investors might employ a valuation cap in SAFE to safeguard their interests if the firm is expanding rapidly or obtain a safe note discount.

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