As an investor or entrepreneur, you might come across the term “simple agreement for future equity” or “SAFE” in your funding negotiations. A SAFE is a legal contract between an investor and a company that provides the investor with the right to purchase equity in the company at a future date, when a predetermined event occurs. Here is what you need to know about a simple agreement for future equity.
What is a Simple Agreement for Future Equity?
A simple agreement for future equity (SAFE) is a type of investment contract that investors utilize to provide a startup with capital. The agreement enables the investor to receive shares in the company at a future date, when a specific event or milestone occurs. The event includes the company’s equity financing, acquisition by a third-party company, or an initial public offering (IPO).
In essence, a SAFE is a promise to issue shares to the investor at a later date. However, unlike a convertible note, the investor does not receive debt or equity at the initial investment. Instead, they receive a contract that provides them the right to purchase equity at a future date.
The Benefits of SAFE
For a startup, SAFEs are a means of raising capital without committing to a valuation or diluting the existing shareholders. The investor receives equity based on the future valuation of the company, which is typically challenging to determine in the early stages of a startup.
From the investor’s perspective, a SAFE provides a simple and straightforward way of investing in a startup without the complications associated with traditional debt or equity investments. They can participate in the future success of the startup without the added risks of equity or debt investments.
How a SAFE Works
When a startup raises capital through a SAFE, it establishes a “cap” and is similar to a pre-money valuation. The cap represents the maximum valuation that the investor is willing to pay for the company.
When an event triggers the conversion of the SAFE into equity, the investor receives shares at a discounted price compared to later investors. The discount on shares may range between 10-30%, depending on the negotiated terms.
In conclusion, a simple agreement for future equity is an innovative way to get funding for startups. With a SAFE, the investor can participate in the future success of the startup without committing to the risks associated with traditional investment options. At the same time, the startup can raise capital without committing to a valuation or diluting its existing shareholders.