SAFE (or simple agreement for future equity) notes are documents that startups often use to help raise seed capital. Essentially, a SAFE note acts as a legally binding promise to allow an investor to purchase a specified number of shares for an agreed-upon price at some point in the future.
SAFE notes are type of convertible security, while convertible notes are a form of debt that can convert into equity once certain milestones are met. Because of this, convertible notes usually have a maturity date and an interest rate. Though convertible notes are a bit more complex, both SAFE and convertible notes are:
SAFES sometimes apply discounts, usually between 10% and 30%, on future converted equity. This discount will apply to the purchase of shares on a future financing round.
For example, if the company offered SAFE note holders a 20% discount and raises money at a $10 million valuation in the future, shares sold to new investors at $10 each means the SAFE investors will buy their shares at $8 each. This is where the 20% discount comes into play.
Another way for the investor to get a better price per share than future investors is through a valuation cap. Valuation caps are a term in SAFE notes that establish the highest price, or cap, that can be used when setting the conversion price.
In cases where there are multiple SAFEs, this term requires that the company notify the first SAFE about it, including the terms for the subsequent note. If the first SAFE holder finds the second SAFE's terms to be more favorable, they can ask for the same terms.
Pro-rata, or participation rights, allow investors to invest extra funds so that they can keep their percentage of ownership during future equity financing.
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