Reading: Simple Agreement For Equity (SAFE)

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4. Valuation Cap and Discount Rate

So far, we have considered SAFEs that either have a Valuation Cap or a Discount Rate. It is also possible to include both elements in the same SAFE. In this case, the mechanics are as follows:

  • When converting the SAFE into SAFE Preferred Stock, either the Valuation Cap or the Discount Rate applies:
    • If the Conversion Price implied by the Valuation Cap is SMALLER than the discounted price per share of Preferred Stock, the Valuation Cap applies and the Discount Rate is disregarded.
    • In contrast, if the Conversion Price implied by the Valuation Cap is LARGER than the discounted price per share of Preferred Stock, the Discount Rate applies and the Valuation Cap is disregarded.
       
  • In the case of a Liquidation, the conversion of the SAFE is the same as a Standard SAFE with a Valuation Cap and NO Discount Rate.

 

Example 1a:

An investor has bought a SAFE for $ 300'000. The Valuation Cap is 4 million and the Discount Rate is 70%. There are currently 2 million shares of common stock outstanding. Now the firm issues 1 million shares of Preferred Stock at a price of $2 each for a total amount invested of $ 2 million. How does this affect the SAFE investor?

 

The SAFE investor can choose between the conversion price that is implied by the Valuation Cap and the discounted issue price of the Preferred Stock: The Maximum SAFE Conversion Price implied by the Valuation Cap is $ 2.00:

 

Maximum SAFE Conversion Price =  \frac{\text{Valuation Cap}}{\text{Number of shares outstanding}} = \frac{4}{2} = 2.00.

 

In contrast, the discounted issue price of the preferred is $ 1.40:

 

Discounted Issue Price = Issue Price of Standard Preferred × Discount Rate = 2 × 0.7 = 1.4.

 

Since the conversion Maximum Conversion Price implied by the Valuation Cap exceeds the Discounted Issue Price, the Discount Rate applies and the Valuation Cap is disregarded. Consequently, the SAFE amount will be converted into SAFE Preferred Stock at a price of $ 1.40, so that the SAFE investors will receive a total of 214'286 shares of SAFE Preferred.

 

Example 1b:

What if the SAFE from above had a Valuation Cap of $ 2 million instead of $ 4 million?

 

In this case, the Maximum Conversion Price implied by the Valuation Cap drops to $ 1.00:

 

Maximum SAFE Conversion Price =  \frac{\text{Valuation Cap}}{\text{Number of shares outstanding}} = \frac{2}{2} = 1.00.

  

Since this conversion price is smaller than the discounted issue price from above ($ 1.40), the Valuation Cap applies and the Discount Rate is disregarded. The SAFE converts at a price of $ 1 into 300'000 shares of SAFE Preferred Stock.