1. Introduction

The preceding sections have shown the many benefits that are associated with preferred stock financing. We have also seen, however, that the negotiation of all these deal terms is complex and requires sophisticated investors and entrepreneurs (and legal counsel). This is especially true early in the life of the company, as there is a great deal of uncertainty about the business model and, importantly, the “fair” valuation of the company. Term sheet negotiations are therefore costly. These complexities are compounded by the fact that seed financing rounds are usually comparatively small, so that the direct and indirect costs of raising preferred stock could simply be too high. For example, many entrepreneurs will be reluctant to spend $25’000 to arrange a $150’000 financing round.

This is where the so-called SAFE contract kicks in. SAFE stands for Simple Agreement for Equity and represents a financing contract that is increasingly popular for seed financing, especially in the Silicon Valley. It was created by Y Combinator in 2013.

The logic of a SAFE is indeed very simple: Instead of negotiating all the deal terms today, the company and the investor agree that the investor will receive company stock at a later date, in connection with a priced liquidity event such as the issuance of Preferred Stock or the liquidation of the company. 

As soon as the company experiences such a liquidity event, the SAFE either converts automatically into equity or the SAFE investors receive their money back, depending on the nature of the liquidity event and the value of the deal. If converted into equity, the SAFE investors then generally receive the same deal terms as the new investors. The only deal element that has to be negotiated with a SAFE are the terms at which the SAFE converts into equity. In this context, the investors and the founders have to agree on the following three elements, which will be discussed in great detail in the next sections:

  • What is the Valuation Cap (if any)?
  • What is the Discount (if any)?
  • Is there a Most Favored Nations (MFN) provision?

 

Based on these deal elements, there are factually four types of SAFE:

  • SAFE with a Valuation Cap and no Discount. This is the so-called "Standard SAFE"
  • SAFE with no Valuation Cap but a Discount
  • SAFE with a Valuation Cap and a Discount
  • SAFE with a Most Favored Nations (MFN) provision, no Valuation Cap and no Discount.

 

Given its simplicity, SAFE represents a single-document financing contract that usually does not exceed 4-5 pages and that is highly standardized. The SAFE template from Y Combinator can be accessed here.

In what follows, we discuss these deal terms, present some examples, and then critically review the benefits and potential challenges that are associated with SAFE.

For your convenience, we have created a simple online tool that allows you to assess the key elements of a SAFE and their implications for the firm's ownership structure and value allocation with a few clicks.