Simple Agreement for Future Equity: A General Guide

What Is a Simple Agreement for Future Equity?

A Simple Agreement for Future Equity (SAFE) is an investment structure, formalized through a financing contract, that allows early-stage startups to invest in themselves by raising capital through a process called seed financing rounds.

It provides investors the right to purchase a specified number of shares in the future from a company, at an agreed-upon price. This price is usually at the same valuation as other investors participating in the SAFE.

The term of the agreement is usually set at no more than seven years and generally includes a 1x return on investment if investors follow through with their commitment to becoming shareholders of record after a three-year holding period.

A SAFE is most commonly offered as part of a convertible note, or SAFE note — a short-term bank loan with an attached conversion option. This type of agreement is commonly referred to as an equity agreement and are formalized through an equity purchase agreement, or contract, that can include an equity commitment letter as well as an investor rights agreement.

Equity agreements protect both parties in a deal of this nature. SAFEs can be used by companies seeking growth capital from angel investors or venture capitalists as part of seed financing rounds.

Here is an article explaining more about a simple agreement for future equity.

What’s Included in a Simple Agreement for Future Equity?

The key terms of a SAFE include the investment amount, the valuation cap, and the conversion discount.

Investment Amount

The investment amount is the amount of money that the investor is investing in the company. Investors are attracted to companies with revenue and growth potential. If you can show investors that you have proof that customers are willing to pay for your product, they will feel more confident investing in you.

Demonstrate traction through metrics like daily active users, monthly recurring revenue (MRR), or sales pipeline. The investment amount is the total amount a startup receives from investors at one time. This figure often has multiple components such as:

• Equity. Equity refers to ownership in a company
• Convertible Debt. Convertible debt refers to funds received by a company that must be paid back with interest before equity financing can be raised again

Valuation Cap

The valuation cap is the maximum value of the company that the investor is entitled to purchase shares. This could be a lower value than the pre-money valuation of the company. The valuation cap may be set by either party; however, it is often set by investors to protect themselves from overvaluation.

• Pre-money valuation cap. This is calculated by multiplying the pre-money valuation by an agreed-upon multiplier (1x, 1.25x, 1.5x).
• Post-money valuation cap. This is calculated by multiplying the post-money (including preferred shares) by an agreed-upon multiplier (1x, 1.25x, 1.5x). For example, A company has been valued at $1 million pre-money and $4 million post-money with a 1x multiplier for preferred shareholders. The investor would then have a right to purchase $3 million worth of shares at $4 million post-money ($4-$1).

Conversion Discount

The conversion discount is the percentage discount that the investor receives on the shares that they purchase. For example, if an investor purchases 100,000 shares at $1.00 per share and their investment has a 5% conversion discount, then they’d receive 95,000 of those shares at $0.95 per share. In this case, they would own 95,000 shares and still have 5,000 left to convert.

Here is an article about what startups should know about a SAFE agreement.

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Types of Simple Agreements for Future Equity

Valuation cap, no discount.

The most common type of SAFE is the valuation cap, no discount SAFE. This type of SAFE does not provide the investor with a discount on the shares that they purchase.

Valuation cap, with discount.

Another type of SAFE is the valuation cap, with discount SAFE. This type of SAFE provides the investor with a discount on the shares that they purchase. The discount is usually between 10% and 20%.

No valuation cap, with discount.

The third type of SAFE is the no valuation cap, with discount SAFE. This type of SAFE does not have a valuation cap but does provide the investor with a discount on the shares that they purchase. The discount is usually between 10% and 20%.

No valuation cap, no discount.

The fourth and final type of SAFE is the no valuation cap, no discount SAFE. This type of SAFE does not have a valuation cap and does not provide the investor with a discount on the shares that they purchase.

Here is an article outlining what a SAFE is.

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What Is the Purpose of a Simple Agreement for Future Equity?

A SAFE is an agreement between an investor and a company that allows the investor to purchase shares in the company at a future date. The agreement is called SAFE because it is a simple agreement that does not have the same terms and conditions as a traditional investment agreement.A SAFE allows a company to raise money from investors without having to go through the traditional equity financing process. This can be a helpful tool for companies that are not ready to go through the equity financing process or for companies that want to raise money quickly.

Here is an article outlining five key things you should know about a SAFE agreement.

Are SAFEs Equity or Debt?

SAFEs are structured with a company's equity as the underlying asset. This means that SAFEs are considered to be equity instruments rather than debt instruments. This is because the equity agreement does not require the company to pay back the investment, with interest, as a debt instrument would.

Here is an article about equity investments vs. convertible debt instruments.

How Does a Simple Agreement for Future Equity Work?

A company will issue a SAFE to an investor in exchange for an agreed-upon price. The SAFE will have a valuation cap and a conversion discount. The valuation cap is the maximum amount of money that the investor can pay for the shares. The conversion discount is the percentage discount that the investor will receive on the shares.The investor will be able to purchase the shares at the valuation cap price at a later date. The shares will convert into equity at a later date, usually when the company raises money through a Series A financing round.

Here is an article outlining key terms and explaining how SAFE agreements work.

Advantages and Challenges of Using a Simple Agreement for Future Equity

One of the main advantages of using a SAFE is that it is a quick and easy way to raise money. SAFEs can be issued in a matter of days, whereas a traditional equity financing round can take weeks or even months to complete.Another advantage of using a SAFE is that it can help a company to avoid some of the costly and time-consuming aspects of the equity financing process, such as hiring a financial advisor or going through a due diligence process.One of the challenges of using a SAFE is that it can be difficult to predict how much money a company will raise. This is because the valuation cap is not set in stone and can change over time.Another challenge of using a SAFE is that it can delay the equity financing process. This is because the investor will not be able to convert the SAFE into equity until a later date, usually when the company raises money through a Series A financing round.

Here is an article outlining the pros and cons of SAFE agreements.

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