The Startup Series | Funding startups with SAFEs: What you need to know
This is the first article in The Startup Series – a collection of short articles covering key concepts for early stage companies in Australia that are establishing a business or raising capital.
What are SAFEs?
A Simple Agreement for Future Equity, or ‘SAFE’, is an agreement where an investor provides funds to a company in exchange for a right to convert that investment into shares on pre-agreed terms when a specified event occurs – typically a future equity round or exit event.
Why SAFEs are commonly used
SAFEs are based on a standardised form with only a few key terms to negotiate. In Australia, the Australian Investment Council’s template is widely used, enabling SAFEs to be drafted quickly and cost-effectively.
SAFEs are also attractive because they defer the need to value the company at the time of investment. This makes them a popular choice for early stage companies looking to raise capital quickly and cost-effectively.
Key terms
Some of the key terms that require consideration and negotiation when a SAFE is entered into are discussed further in the table below.
| Main negotiable term | Meaning |
|---|---|
| Valuation Cap | While not required, a valuation cap sets a maximum value that the company will be deemed to be valued at when the SAFE converts into shares. This protects the SAFE holder by placing an upper limit on the price per share at which their initial investment will convert. |
| Discount | Like a valuation cap, a discount is not required but is often requested by a potential SAFE holder. A discount ensures the SAFE holder’s original investment is converted at a reduced share price relative to later-stage investors. In essence, this is the ‘reward’ that the SAFE holder receives for investing in the company early. |
| Conversion Trigger | This is the trigger event which will result in the conversion of the SAFE holder’s investment into shares. Typically, this will be a financing round that raises over a fixed dollar amount of new money (e.g., $1m) or an exit event. |
| Treatment when there is a liquidation scenario | Some SAFEs will provide that the SAFE holder will receive priority payment over shareholders in the event that an insolvency event occurs, whereas others will provide that the SAFE holder ranks equally with other shareholders. |
In addition to the foregoing, an investor may want to enter into a separate side letter with the company to secure most favoured nation rights, pre-emptive rights and/or information rights before the SAFE has converted into shares given that the investor will not be a shareholder during that time (unless the SAFE holder has already made a separate equity investment).
Comparison with other capital raising methods
| Investment type | Key characteristics |
|---|---|
| SAFE | • A contractual right to receive shares in the future • No shares issued upfront and therefore more founder friendly as there is no dilution at the time when the investment is made • Conversion happens when a specified event occurs (such as a funding round) • Not secured and no interest payable • Generally simpler and easier to negotiate than other investment types (such as a direct share investment or a convertible note) • No maturity date and in theory no shares will ever be issued if the conversion triggers don’t occur • Whether the SAFE ranks ahead of equity in a liquidation scenario will depend on the terms of the SAFE |
| Convertible note | • A debt instrument that generally requires the company to pay interest (the 'coupon') • Has a maturity date by which the face value of the convertible note must be repaid or the note will convert into shares • Less founder friendly as interest is generally payable on amount invested and there is a maturity date by which the note must be repaid or will convert (whereas a SAFE will only convert if and when the agreed trigger event occurs) • In a liquidation scenario, ranks higher then equity but lower then secured debt (unless security has been granted in connection with the issue of the note). |
| Shares (via a share application or subscription agreement) | • Involves an immediate issue of shares at an agreed value per share • Investor becomes a shareholder straight away and, as a result, it is likely that a shareholders’ agreement will also need to be agreed as part of the investment (or the incoming shareholder will need to accede to the terms of any existing shareholders’ agreement) • Ownership percentage is fixed upfront • In a liquidation scenario, will rank lower than debt (including convertible notes) |
Final thoughts
SAFEs are a practical, efficient and commonly accepted way for early stage companies to raise capital. They offer low costs and complexity up front, in part due to delaying the need to conduct a valuation of the applicable company.
If you are considering using a SAFE for your business or entering into one with a company that you are looking to invest in, please contact us and we would be delighted to assist.
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Authored by:
Vaughan Petherbridge, Partner
Kosta Arvanitakis, Graduate
Get in touch
- Vaughan Petherbridge
- Partner, Melbourne
- +61 3 9252 7766
- vaughan.petherbridge@gadens.com
