3. Discount Rate

The second important SAFE element is the so-called Discout Rate. The Discount Rate applies to the price at which the company subsequently issues equity in a priced financing round and therefore allows SAFE investors to buy Standard Preferred Stock (or Common Stock) at a comparatively lower price.

The Discount Rate is calculated as 100% minus the percent discount the SAFE investors are entitled to. For example, if SAFE investors are entitled to a discount of 20% (they can buy Standard Preferred Stock 20% cheaper than subsequent investors), the Discount Rate is 80% [= 100% - 20%].

  

Let's look at the mechanics of a SAFE with a Discount Rate but NO Valuation Cap. Later, we will complete the picture and discuss SAFEs that have a Valuation Cap as well as a Discount Rate.

 

SAFE with Discount Rate and no Valuation Cap

Example 1a:

Suppose an investor has purchased a SAFE for $200'000. There is no Valuation Cap but a Discount Rate of 80%. Now the company issues shares of Standard Preferred Stock at a price of $ 1 each. At what price will the SAFE be converted into Standard Preferred Stock?

Given a Discount Rate of 80%, SAFE will be converted at a price of $ 0.80:

 

SAFE Conversion Price = Issue Price of Standard Preferred × Discount Rate = 1 × 0.8 = 0.8.

 

Consequently, the SAFE investors will recieve 250'000 shares of Standard Preferred Stock [= 200'000 / 0.8].

 

In the case of a liquidity event, the investor can have the purchase amount repaid (liquidation preference) or convert the SAFE into shares common stock at the fair market value of common stock times the Discount Rate. In this case, the computations are a bit more complicated. The online tool for the SAFE mechanics takes care of them. The quick reader can therefore skip the next example.

 

Example 1b:

Suppose the same company as above (SAFE of 200'000, Discount Rate of 80%) is acquired for 10 million. There are 1 million shares of common stock outstanding. At what price will the SAFE investors be able to convert their shares into common stock?

From above, we know that SAFE investors will receive shares at a discounted price. The number of shares they receive corresponds to the SAFE amount, divided by the discounted purchase price:

 

New Shares of Common Stock to SAFE = \( \frac{\text{Safe Amount}}{\text{Stock Price}\times \text{Discount Rate}} \)

 

The total number of shares outstanding for the acquisition corresponds to the currently issued number of shares (1 million) plus the new shares issued. 

 

Total Number of Shares = \( \text{Issued Shares} + \frac{\text{Safe Amount}}{\text{Stock Price}\times \text{Discount Rate}} \)

 

For each of these shares of common stock, the aquirer pays a certain stock price such that the total deal consideration is 10 million:

 

Deal Consideration = \( \text{Stock Price} \times (\text{Issued Shares} + \frac{\text{Safe Amount}}{\text{Stock Price}\times \text{Discount Rate}}) \) 

 

Solving this expression for the Stock Price, we get:

 

Stock Price = \( \frac{\text{Deal Consideration} - \frac{\text{Safe Amount}}{\text{Discount Rate}}}{\text{Issued Shares}} \)

 

Using the numbers from our example, the acquirer will, therefore, offer to pay a price of $ 9.75 per share of common stock:

  

Stock Price = \( \frac{10'000'000 - \frac{200'000}{0.8}}{1'000'000} \) = 9.75.

 

Consequently, the SAFE investors will convert at a price of $7.80, which corresponds to the offered Stock Price times the Discount Rate:

 

SAFE Conversion Price = Stock Price × Discount Rate = 9.75 × 0.80 = 7.80.

 

The firm therefore issues 25'641 new shares to the SAFE investors:

 

New Shares of Common Stock to SAFE = \( \frac{\text{Safe Amount}}{\text{SAFE Conversion Price}} = \frac{200'000}{7.8} \) = 25'651.

 

This increases the total number of shares outstanding to 1'025'641. At an acquisition price of $ 9.75 per share, the acquirer will therefore indeed pay a total consideration of 10 million. With 25'641 shares, the SAFE investors capture a total value of 250'000:

 

Value to SAFE investors = New Shares to SAFE × Stock Price = 25'641 × 9.75 = 250'000.

 

Converting the SAFE into common stock is therefore the financially more attractive liquidation option than having the purchase price returned ($ 200'000).