A Simple Agreement for Future Equity (SAFE), is an agreement between an investor and you (the founder) to get money now in exchange for the promise that the investor will receive equity in your company at an undefined future date when your company raises a priced round (e.g. Series A).
Why raise using SAFEs? For an early-stage startup, it's hard to accurately value your company because you might have minimal data points. That’s where a SAFE can be used as a form of financing. With SAFEs, you can postpone your startup’s valuation until you have a good MVP(Minimum Viable Product).
Investors agree to make a cash payment to a company in exchange for a contractual right to convert that amount into shares when they raise equity round.
A SAFE is neither debt nor equity, and there is no interest accruing or maturity date. They are simple, standardised documents, easy to use, fair for all parties, and have little to zero in transaction costs for you and your investors. However, there are important differences between Pre-Money SAFE and Post-Money SAFE that you, as a founder or investor, should carefully examine.
Most early-stage founders and investors that we’ve encountered have difficulties in choosing between the Pre-Money SAFE and Post-Money SAFE. This is because they don’t understand the difference. These are two standardized legal documents that Y Combinator has introduced in recent years. To view the documents, click here.
Hold on! Before you go, keep reading... We’ll simplify it for you. Our goal today is that by the end of this article, you can explain SAFEs to your grandparents or friends.
Let’s start at the very beginning. In late 2013, Y Combinator introduced the Pre-Money SAFE (also known as the original SAFE). Since then, almost all YC startups and other startups across the globe (even in the African continent, particularly in Nigeria) are using it as the main instrument for early-stage fundraising. This was to act as a replacement for convertible notes (click here to view our previous blog on this).
The Pre-Money SAFE is standardized on a pre-money valuation. The investors receive pro-rata rights. What is pro-rata rights? Pro-rata right is the right for the SAFE investor to purchase more shares in the company if the company raises a subsequent round of financing. The advantage of this SAFE is it favours the companies because you can delay the valuation of your company.
More startups have been issuing Pre-Money SAFE and convertible rounds, this has made it difficult to keep track of both founders and investors’ relative ownership stakes as the companies keep adding investors in subsequent rounds. We’ve seen some startups raising bigger ticket rounds as an alternative to seed rounds. Because of this, in September 2018, YC introduced the Post-Money SAFE.
Post-Money SAFE is an improved version of the original SAFE. What is the difference? This round can be treated as a seed round, and the valuation cap is post-money, both startups and investors have clarity of ownership and future dilution. They also removed the pro-rata rights that existed in the original SAFE, unless the company approves to grant this to the investor. A significant disadvantage here is that the Post-Money SAFEs investors will not participate in any dilution of subsequent financing rounds until the Post-Money SAFE converts at a priced equity round. Post-Money SAFE investors are getting a better deal than Pre-Money SAFE holders on the cap table. The tradeoff is the increased clarity of ownership and future dilution (to incentivize more investor confidence, and thus more capital invested).
#RaiseTip: How to Decide Between Pre and Post-Money SAFEs?
When deciding which version is right for your company, start by considering the level of funds you’re planning to raise in that round. Pre-Money SAFE is typically the better option for small, initial financing rounds. With Post-Money SAFE, you can accurately track ownership and dilution changes during that fundraising round and in future rounds. You can also negotiate pro-rata rights. Post-Money SAFE is often the SAFE of choice for companies that are confident their next round of fundraising will be equity round.
Until the next post! #keepbuilding
DISCLOSURE: This communication is on behalf of Raise Impact Technologies Inc., (“Raise”). This communication is not to be construed as legal, financial or tax advice and is for informational purposes only. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Raise does not assume any liability for reliance on the information provided herein.