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What Is a SAFE Note?

SAFE (or simple agreement for future equity ) notes are financial agreements 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.

The Securities Exchange Commission (SEC) defines a SAFE as "an agreement between you, the investor, and the company in which the company generally promises to give you a future equity stake in the company if certain trigger events occur." [1]

See SAFE Note Pricing by State

How SAFE Notes Work

When a company is first starting out, there is typically very little data, making it difficult to assign the company a valuation. SAFE notes work by allowing you to postpone the company's valuation until a later date by promising investors a set of terms for when their investment will convert into equity. The terms often used are valuation caps and discounts, both of which reward the early investors for the risk they have taken.

How Valuation Caps Work

A valuation cap essentially sets a maximum (or ‘cap’) on the valuation the investors money can convert into equity. This means if the startup raises future financing at a valuation above the valuation cap promised to the SAFE note holders, their money will convert into equity at the price of the valuation cap (not the higher valuation), giving them a discount on the shares they will receive.

Here is an example of what you may see in a SAFE note "The “ Pre-Money Valuation Cap ” is $9,000,000." [2]

How Discounts Work

A discount will allow SAFE Note holder’s money to convert into equity at a discounted rate compared to the next round of investors. For example, if the startup raises a future financing round at a valuation lower than the valuation cap, the SAFE Note holders’ investment will convert into equity at a discounted rate.

Here is an example of what you may see in a SAFE note "The “ Discount Rate ” is 20%." [3]

No Interest, Maturity Date, or Repayment Terms

Unlike convertible notes, SAFE notes are not debt and do not have an interest rate, maturity date, or any sort of repayment terms. This is one of the main reasons they are attractive to startups, since they are a way to get investment in within taking on any burden of debt. The incentive for the investors is the benefits they will receive through the valuation cap or discount, depending on what the startup offers.

Pre-Money vs. Post-Money SAFE notes

It is worth noting there are commonly used types of SAFE notes. These are pre-money SAFEs and post-money SAFEs. The main difference is a pre-money SAFE note's valuation cap is calculated from the pre-money valuation of the startup, meaning the valuation of the startup before money is invested in the next financing round. A post-money SAFE's valuation cap is calculated against the post-money valuation of the startup, which includes the money being invested in the next equity round.

For example, if a startup issued pre-money SAFE notes with a $4 million valuation cap, and the startup raises $2 million in their next financing round at a post-money valuation of $12 million, the valuation cap would be compared to $10 million pre-money valuation (does not include the money being invested) as opposed to the $12 million post-money valuation (which includes the new capital being invested).

Example Steps for Using a SAFE Note

Here's a look at the basic steps that take place when utilizing a SAFE note for your startup:

  1. An investor provides seed money in exchange for promised future equity.
  2. The company uses the original investment to build the business.
  3. Once progress has been made, you find another investor, giving your company what is known as post-money valuation.
  4. You can then calculate the company's new price per share with this information.
  5. After you know the price per share, you can convert the SAFE note into the applicable number of shares in the company and distribute them to the SAFE investor. SAFE notes typically convert after an equity financing round, like a Series A round.

SAFE Note Templates

Purchase and download templates drafted by lawyers in our network that match your needs.
Pre-Money SAFE Note (Discount, Valuation Cap)
Discount Rate & Valuation Cap
Pre-Money SAFE Note (Valuation Cap Only)
Valuation Cap, No Discount Rate
Post-Money SAFE Note (Discount, Valuation Cap)
Discount Rate & Valuation Cap
Post-Money SAFE Note (Valuation Cap Only)
Valuation Cap, No Discount Rate
SAFE Note (Discount Only, No Valuation Cap)
Discount Rate, No Valuation Cap
*By purchasing a template, you acknowledge that you have read and understood ContractsCounsel's Terms of Use.

Key Elements in a SAFE Note

SAFE notes contain a few primary terms that alter how they eventually convert to company shares, and they are:

  • Discounts: SAFEs sometimes apply discounts, usually between 10% and 30%, on future converted equity. This means that the investor will be purchase shares at a discount on the future financing. For example, if the company offered SAFE note holders a 20% discount and achieves a valuation of $10 million, with shares available to new investors at $10, the SAFE investors will be able to buy their shares at $8, thus receiving a 20% discount.
  • Valuation Caps: 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.
  • Most-Favored Nation Provisions: 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 Rights: Pro-rata, or participation rights, allow investors to invest extra funds so that they can keep their percentage of ownership during future equity financing.

SAFE Notes vs. Convertible Notes

SAFE notes are a 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:

  • Helpful tools for startups trying to grow or scale their business.
  • Converted to equity eventually.

Overall, the biggest difference to know between SAFE notes and convertible notes is that SAFE notes do not have a maturity date, interest rate, or any repayment obligations.

SAFE Note Conversion Examples

After early investments, SAFE notes will typically convert into equity if the startup hits their milestones and reaches a ‘trigger event.’ A trigger event is an event that causes the SAFE notes to convert into equity according to their predefined terms offered to investors.

The SEC defines "Conversion Terms" as "These are the specific terms by which the amount you invested in the SAFE gets converted into equity." [4]

Below are two common examples of SAFE note trigger events:

Equity Financing Round

If a startup can raise an equity financing round by selling preferred stock to new investors, this will ‘trigger’ the SAFE notes to convert into preferred stock. Shares will be priced according to the terms of the SAFE notes, which typically uses the valuation cap or discount. For example, if the equity financing round (e.g., series A round) values the company above the valuation cap agreed to with the SAFE note holders, their investment will convert into shares at the price of the valuation cap which gives them a lower price per share than the new investors.

Sale of the Company

If a startup is acquired before an equity financing round, this will trigger the SAFE notes to convert into equity. Typically, the SAFE notes will convert into equity right before the sale is made so that the investors can participate in the proceeds of the sale. The SAFE notes will convert based on the terms of their agreement.

Safe note

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Advantages of Using SAFE Notes

There are several benefits of using SAFEs, including that they:

Are Less Complex Than Other Options

One of the primary benefits of SAFE notes is that they are typically less than five pages long and are simple enough for anyone to understand. This is largely due to the fact that there aren't any end dates or interest payments to worry about, unlike with a convertible note.

Contain Important Stipulations

SAFEs protect both startup companies and investors by including key agreements for potential future occurrences, such as:

  • Changes of control
  • Early exits by investors and company owners
  • Company dissolution
  • Bankruptcy

Have Simple Accounting Requirements

SAFE notes are included in a company's capitalization table, eliminating the need for any complicated tax consequences.

Provide Fewer Points for Negotiation

Since SAFEs are so simple, there are fewer terms to negotiate, making everything that needs to be discussed clear and concise. In fact, the only things that really need to be negotiated are the discount rate and the valuation cap.

Give Company Owners More Control

Without repayment obligations and maturity dates looming over your head, you end up having a lot more freedom and flexibility as a company owner.

Offer Better Benefits for Investors

Since SAFE notes are converted into preferred stock, often at a discounted price, investors have a lot of incentive for using them. Investors could end up with benefits that are actually better when compared to their original investment.

The Challenges of Using SAFE Notes

SAFE notes offer a number of benefits, but they do come with their fair share of challenges, such as that they:

Can Be Risky

Because a SAFE note's outcome depends on how the company progresses, investors don't have a guarantee that it will ever convert into equity.

Don't Offer Continual Revenue

Convertible notes provide investors with continual interest payments. SAFE notes aren't a loan, meaning investors don't receive any sort of interest or payments. As a result, investors sometimes end up making less over time.

Don't Provide Dividends

A lot of companies provide dividends, either in the form of payments or additional shares, to investors when the company performs well. In most cases, SAFEs don't supply investors with dividends. Instead, an investor's reward for investing in a SAFE is equity. It is worth noting that the type of companies that are financed using SAFE Notes would not plan to pay dividends to investors. Any profits generated are typically put back into the business for growth.

Have an Unknown Future Impact

SAFEs weren't developed until 2013, when the team at Y Combinator, a Silicon Valley accelerator, decided that there needed to be a financial tool that made seed investment a little less complicated. In the short-term, this new financial instrument is efficient and effective, but we're still unaware of the potential long-term consequences for company owners and/or investors. Additionally, the newness of SAFE notes means that investors and lawyers are often less familiar with them, and, therefore, wearier of using them.

Require the Business To Be Incorporated

In order to use SAFE notes during negotiations, a company has to be incorporated. This is because this type of investment is included in a C corporation 's capitalization table, just like other stock options. That means that if you're hoping to issue SAFE notes and your business is structured as a limited liability company, or LLC, you will have to:

  • Restructure.
  • Become incorporated.
  • Obtain the necessary legal services.
  • Pay applicable fees.

May Necessitate a Fair Valuation

Another possible expense associated with issuing SAFE notes is the potential need for a fair valuation, also known as a 409a, to appraise your startup stock's fair market value.

Lack Minimum Requirements

SAFEs don't have a minimum requirement for equity to enter conversion, which can have a negative impact on future investments. Minimum requirements allow you to readjust the note's terms, giving smaller investors the opportunity to compete.

Could Dilute the Company's Valuation

Company owners could unknowingly end up owning fewer shares in their company down the road because they forget to account for any potential dilution. As a result, investors will be less inclined to invest in the company.

As a startup, finding funding is often one of the very first challenges that you'll face. By knowing your options and learning about their advantages and disadvantages, you can make the right decision for you and your company. SAFE notes, while still fairly new, provide an excellent opportunity for you to develop your business without the threat of impending interest payments looming overhead.

What Happens to SAFE Notes if a Startup is Acquired?

The acquisition of a startup is considered a ‘trigger event,’ which means the SAFE notes will convert into equity based on the terms of their agreement. The conversion typically takes place right before the sale happens, so that the SAFE note holders can participate in the proceeds of the sale.

Depending on the terms of the acquisition and SAFE note, investors may receive cash proceeds, equity in the acquiring company, or both. It is worth noting that SAFE notes convert into preferred stock, so depending on the liquidation preferences, SAFE note holders may be entitled to receive the proceeds of the sale before common stock holders of the company.

Common Types of SAFE Notes

When issuing a SAFE note, you the most common scenarios are:

  • A valuation cap, but no discount
  • A discount, but no valuation cap
  • A valuation cap and a discount
  • No valuation cap and no discount

References

  1. ^ https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_safes
  2. ^ https://www.sec.gov/Archives/edgar/data/1657493/000121390021030690/ea142082ex5-2_rentberry.htm
  3. ^ https://www.sec.gov/Archives/edgar/data/1657493/000121390021030690/ea142082ex5-2_rentberry.htm
  4. ^ https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_safes

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Securities

SAFE Note

New York

Asked on Mar 30, 2021

What is the difference between a SAFE Note and Convertible Note?

I am considering raising money and have been advised to look at these two instruments to raise money on.

Ramsey T.

Answered Mar 30, 2021

Both SAFES (Simple Agreements for Equity) and Convertible Notes "convert" into equity. The fundamental difference between the two is that SAFES have no built-in interest rate and have no "end date." Convertible Notes are debt so they have an interest rate and after a certain period of time (perhaps two years in most cases) they can be "cashed in" by the holder who can force the start-up to pay back the investor (principal plus interest). SAFES have become very accepted in the investing community at this time and I always recommend that a start-up issue SAFES (and conversely I always recommend that an investor get a convertible note).

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Securities

SAFE Note

California

Asked on Jul 13, 2023

SAFE Note interest accrual?

I am a business owner who recently completed a Series A round of funding. As part of this funding round, I issued SAFE Notes to my investors. I am now trying to understand the implications of these notes, specifically regarding interest accrual. I want to make sure I am compliant with all the terms of the SAFE Note agreement and understand the effects of interest accrual on my company's finances.

Thaddeus W.

Answered Aug 11, 2023

Thanks for the interesting question. There may be some conflation of issues here. A few points may help to clarify -- 1. A SAFE and a Note are different animals. Notes are debt instruments and, accordingly, usually have an interest component. SAFE's are not debt and so do not accrue interest. Convertible Notes and SAFE's are similar in that they both typically convert into preferred stock when the company **later** issues preferred stock. Also, Convertible Notes and SAFE's are often issued without regard to a company's then-current valuation. 2. You said your company issued SAFEs / Notes "as part of" a Series A funding. That's not legally impossible, of course, but it would be unusual, so it would be helpful to make sure we are using the same "glossary" of terms. Typically, the phrase "Series A funding" refers to a company's issuance of Series A Preferred Stock; such transactions involve putting a value on the company so that the Series A stock can be priced. Series A rounds often are preceded by the company issuing Convertible Notes or SAFE's without a valuation of the company (that is, the company and investors "kick the can down the road" to a later time when the company's operating history can justify a valuation). Then, when the Series A round occurs and shares of Series A are priced based on the company valuation, any pre-existing Convertible Notes and SAFE's convert into shares of Series A preferred stock at a conversion price that is equal to the price paid by the Series A purchasers, minus the discount that the Convertible Notes or SAFE's give to their holders. (NOTE: these days, often there is a round of preferred stock sold BEFORE Series A, called Series Seed. This is not required, but common. Sometimes SAFE's or Notes are issued between Series Seed and Series A, but, again, it would be the odd investor who purchased a SAFE or a Note in the same financing round in which preferred stock is sold.) 3. The implications of SAFE's and notes can be several. One of the biggest is their impact on the company's capitalization table ... that is, on the ownership interests of other shareholders, especially the founders. The terms of each Note or SAFE will determine their impact when they convert, especially if they have a "valuation cap" ... which is a provision by which an effective discount is given to the holder of the SAFE / Note. Valuation caps can result in more dilution to the founders and other pre-existing shareholders than they might expect, depending on the actual valuation of the company when these Convertible Notes and SAFE's do convert. 4. If you issued Convertible Notes or SAFE's as part of a Series A preferred stock round, the investors purchasing the Series A would have to have known about and approved of it. Their lawyers would have certainly raised eyebrows and asked questions. If these Convertible Notes / SAFE's were issued outside of the knowledge of the Series A investors, this would be expected to be problematic for the company, and possibly a breach of the Series A investment documents, or even a violation of certain securities laws. But, if all was approved by the investors, no problem. 5. Another implication worth noting is that since Convertible Notes are debt, they typically would be carried on (shown in) the company's balance sheet. Investors in Series A round always or nearly always have Information Rights to see the company's financial statements and be kept current on changes. Normally the company would have a contractual obligation to provide quarterly, if no monthly, financial reports and updates to Series A investors. These reports should include all information about SAFE's and Notes. 6. It should also be noted that Series A investment documents typically restrict the company from issuing many types of new securities without the approval of what these docs often call the "Requisite Holders." This is a defined term in the Series A investment docs (normally in the company amended and restated Charter), and is defined as the Series A holders that hold at least a stated number (e.g., a majority) of all of the Series A shares sold in the round. Note that these answers are not and should not be taken as legal advice for your particular situation. You should retain qualified legal counsel to have a formal lawyer-client relationship and your lawyer should review all relevant information. But, these concepts here are pretty fundamental. ~Thaddeus Wojcik, Wojcik Law Firm, PC

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Accounting

SAFE Note

Connecticut

Asked on Aug 3, 2023

SAFE Note accounting treatment?

I am an entrepreneur looking to raise capital from investors using a SAFE Note. I need to understand the accounting treatment of the SAFE Note so I can accurately record it in my financial statements. Additionally, I need to understand the implications of the accounting treatment of the SAFE Note for my investors.

Thomas L.

Answered Aug 4, 2023

A SAFE is a stock warrant. Thus it should be accounted for as such, meaning equity. "The two main rules to account for stock warrants are that the issuer must recognize the fair value of the equity instruments issued or the fair value of the consideration received, whichever can be more reliably measured; and recognize the asset or expense related to the provided goods or services at the same time. The following additional conditions apply to more specific circumstances: Option expiration. If the grantor recognizes an asset or expense based on its issuance of warrants to a grantee, and the grantee does not exercise the warrants, do not reverse the asset or expense. Equity recipient. If a business is the recipient of warrants in exchange for goods or services, it should recognize revenue in the normal manner. The grantor usually recognizes warrants as of a measurement date. The measurement date is the earlier of the date when the grantee’s performance is complete; or the date when the grantee’s commitment to complete is probable, given the presence of large disincentives related to nonperformance. Note that forfeiture of the warrant instrument is not considered a sufficient disincentive to trigger this clause. If the grantor issues a fully vested, nonforfeitable warrant that can be exercised early if a performance target is reached, the grantor measures the fair value of the instrument at the date of grant. If early exercise is granted, measure and record the incremental change in fair value as of the date of revision to the terms of the instrument. Also, recognize the cost of the transaction in the same period as if the company had paid cash, instead of using the equity instrument as payment. The grantee must also record payments made to it with equity instruments. The grantee should recognize the fair value of the equity instruments paid using the same rules applied to the grantor. If there is a performance condition, the grantee may have to alter the amount of revenue recognized, once the condition has been settled."

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Investments

SAFE Note

Connecticut

Asked on Aug 10, 2023

When to use a SAFE Note?

I am a small business owner looking to raise funds for my business. I have been exploring different financing options, and I have recently come across SAFE Notes. I'm not sure when to use a SAFE Note, and how it could benefit my business. I am hoping to learn more about how SAFE Notes work and when they should be used.

Thomas L.

Answered Aug 15, 2023

SAFEs are used by growth capital technology startups who are planning to sell multiple rounds of preferred stock to investors. A SAFE is a stock warrant, meaning, the pre-purchase of a later issuance of stock. If you are planning to sell multiple rounds of preferred stock to investors, then a SAFE is a quick way to raise smaller amounts of capital in advance of selling a big preferred stock round.

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