Cracking The SAFE Open
Should you choose SAFE funding? And what is SAFE anyway? Here are all the answers
Although relatively new, simple agreement for future equity (SAFE) funding is becoming a favorable fundraising method for founders as well as investors. While offering funds with a comfortable return policy to the founders, allows investors to enjoy the fruits of their investments when they are ripe.
This article will cover this SAFE related questions:
- What is SAFE funding?
- How does SAFE work?
- Why do investors often loan via SAFE?
What is SAFE funding?
In 2013, Y Combinator, an American accelerator for start-ups, established a new investment method. In order to assist companies looking to fundraise small amounts or struggling to find an investor, it became an effective solution. The SAFE method defines that an investor can fund a company and in return receive shares at a later, predetermined event or time. However, the conditions vary, commonly SAFE is triggered when a company goes through a process that validates its value (a company’s fair market value valuation or funding round for example).
SAFE allows a founder to receive an investment without labeling a value to the company shares. When it's finally time for the investor to receive his shares, a calculating method will be activated. As each case will provide different revenue for the investor, the method of calculation will change according to the profitability of each method.
Although SAFE is considered to be a convertible loan, it holds an important difference: SAFE usually does not accumulate interest. The time that has passed from signing the SAFE until its activation shouldn't affect the deal one bit.
How does SAFE funding work?
Often a company that needs a relatively small amount of money or struggles to raise via a funding round, will resort to SAFE funding. Sometimes, when an investor who hesitates to invest a large amount will find it acceptable to invest under a SAFE agreement. When both sides agree to a SAFE and the terms are set, two main calculation methods are stated: Discount and Valuation Cap.
This method dictates a pre-set discount in percentage, this discount will be deducted from the share value at the moment of the stock validation event. The discount is always from the PPS of the new round, for example: if a company raised preferred A shares at a PPS of 5$, and the discount is 25%, the PPS for the SAFE holder will be 5*(1-25%). The validation doesn't need to be a complex one such as a 409A valuation, sometimes a post-money valuation will do. The event conditions will be sealed in the SAFE agreement so both sides will know exactly how to address each situation.
Here the shares will be subjected to a set price but with a cap on the minimum value. Investors funding companies that increase their value over time won't meet this minimum as it defines the lowest share price compared to the entire company’s value. This method will commonly increase its profitability as the company value rises so it is safe to say investors' shares will be calculated by this method for highly profitable companies.
Why do investors often invest via SAFE?
The answer to this question is a bit tricky since most investors don’t invest via SAFE, but those who do have several reasons:
Small investment amount
We explained earlier that when a company needs only a relatively small amount, it will turn to SAFE funding, which is also true for investors looking to divide their portfolios. Others just don’t have huge amounts to spare and have short budgets yet look to invest.
Companies with a lot of potential but require just a small amount until their next round or an IPO might be a dream deal for some investors. To create a hugely successful business a small push is sometimes required and companies that show progress while looking for that small push, are considered a safe investment.
Often friends or family looking to show their belief in your company will offer funds. Receiving their investment under a SAFE is a decent way to receive this small amount without signing it as a round.
SAFE funding is a method to sell shares of a private company to an investor without listing it as a funding round. Unlike other convertible loans, SAFE usually does not accumulate interest. SAFE is often for smaller amounts and gives many benefits to the investor while allowing the founder to raise funds when he struggles in his funding round.
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