What is a SAFE ?
A SAFE, or Simple Agreement for Future Equity, represents an option or right to a future stake in a company, triggered by a specific event, such as fundraising. The terms of a SAFE agreement often include a discount rate and/or a valuation cap, helping to protect the initial investor by offering a more favorable conversion price when the shares are converted.
This type of contract was created in 2013 by Y Combinator to streamline the fundraising process for young start-ups by avoiding the complex valuation assessment of early-stage companies.
How to calculate the conversion price of the SAFE ?
Note: In this part, we are only talking about the post-money SAFE, which is nowadays the most used SAFE instrument. To understand the difference between pre-money SAFE and post-money SAFE, see the dedicated section below.
The specific feature of a SAFE is that its conversion price is not known at the time of investment, as it depends on the next round of exercise. In fact, the conversion price depends on two parameters :
- the terms of the SAFE
- the company's pre-money valuation at the time of the next financing round.
Let's take a look at some typical SAFE terms examples and the resulting exercise price.
SAFE with a Discount
Here the SAFE Price is calculated by applying the discount to the next round price per share
Let's consider a SAFE investment of $1M contracted in 2020 with a 20% discount. Before SAFE conversion, the company had 1 million shares. At the SAFE investment date, the investor does not know at which valuation they have invested.
Let's also consider that in 2021, the company raises a round at a valuation of $5M.
What will be the price per share paid by the SAFE investor?
The steps to follow to determine the price per share paid by the SAFE investor are as follows:
- Determine the PPS paid by the new round investors: The price per share paid by the new investors is the pre-money valuation / the number of company shares before SAFE conversion and the new round, or $5M / 1M = $5.
- Infer the discounted SAFE investor PPS: SAFE investors benefiting from their 20% discount will pay for each share the price of (1 - discount of the SAFE) * new round PPS, or (1 - 20%) * $5 = $4.
What percentage of the company will be owned by the SAFE investor?
The steps to follow to percentage of the company owned by the SAFE investor are as follows:
- Determine the number of shares owned by the SAFE investor: The number of shares owned by the SAFE investor is the amount invested by the SAFE investor / the SAFE investor PPS, or $1M / $4 = 250K shares.
- Determine the total number of shares after SAFE conversion:The total number of shares after SAFE conversion is the number of shares before SAFE conversion + the number of shares owned by the SAFE investor, or 1M + 250K = 1.25M shares.
- Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the number of shares owned by the SAFE investor / the total number of shares after SAFE conversion, or 250K / 1.25M = 20%.
Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.
SAFE with Valuation Cap
Here, the SAFE price is calculated on the basis of the lowest valuation between the valuation cap and the valuation of the financing round.
Let's consider a SAFE with a $3M valuation cap contracted in 2020 by an investor for $1M. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $5M.
What percentage of the company will be owned by the SAFE investor?
The steps to follow to determine the percentage of the company owned by the SAFE investor are as follows:
- Determine the valuation for SAFE conversion: The lower of the financing round valuation or the valuation cap is used for the SAFE conversion. Here, the valuation cap ($3M) is lower than the valuation of the financing round ($5M). Therefore, the valuation for SAFE conversion is $3M.
- Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the amount invested by the SAFE investor / valuation for SAFE conversion, or $1M / $3M = 33%.
Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.
What will be the price per share paid by the SAFE investor ?
The steps to determine the price per share paid by the SAFE investor are as follows:
- Determine the total number of shares after the SAFE conversion: The new total of shares is calculated so that the new shares issued represent the % ownership of the SAFE investor, i.e., 33%. The new total number of shares is therefore the total number of shares before the SAFE / (1 - % ownership of the SAFE investor), or 1M / (1 - 33%) = 1.5M shares.
- Infer the number of shares owned by the SAFE investor: The number of shares held by the SAFE investor is equal to the total number of shares x the SAFE investor's % ownership, or 1.5M x 33% = 500K shares.
- Calculate the PPS based on the Shares: The price per share paid by the SAFE investor is equal to the amount invested by the SAFE investor / the number of shares owned by the SAFE investors, or $1M / 500K = $2.
What would happen if the financing round valuation was lower than the valuation cap?
If the financing round were $2M, then the $3M cap would not apply because it exceeds the value of the round, and the investor would buy at the same price as the other investors (based on the $2M valuation).
SAFE with Discount and Valuation Cap
If the SAFE contracted by the investor contains both a cap and a discount, the SAFE will be converted to the most attractive PPS.
Therefore, the SAFE Price = min(SAFE with Discount price; SAFE with Valuation Cap price).
SAFE with a Valuation Floor
While the valuation cap is a security for the SAFE investor, guaranteeing them a minimum percentage holding in the next round of financing, it can be risky for founders. Indeed, if the valuation of the next round is lower than expected, the founders may lose a vital part of their ownership to the SAFE investor.
The solution proposed by the SAFE creators to limit this undesirable effect is the valuation floor.
Here the SAFE price is calculated on the basis of the highest valuation between the valuation floor and the valuation of the financing round.
Let's consider a SAFE with a $3M valuation floor contracted in 2020 by an investor for $1M. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $1.5M.
What percentage of the company will be owned by the SAFE investor?
The steps to follow to determine the percentage of the company owned by the SAFE investor are as follows:
- Determine the valuation for SAFE conversion: The higher of the financing round valuation or the valuation floor is used for the SAFE conversion. Here, the valuation floor ($3M) is greater than the valuation of the financing round ($1.5M). Therefore, the valuation for SAFE conversion is $3M.
- Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the amount invested by the SAFE investor / valuation for SAFE conversion, or $1M / $3M = 33%.
Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.
SAFE with MFN
The MFN or Most-Favored Nations clause gives the SAFE investor the right to be aligned with the best SAFE terms (or any other convertible securities) offered in the future by the company.
This clause can be introduced in any type of SAFE contract and applies as long as the SAFE has not ended.
Let's consider a SAFE with a $5M valuation cap and an MFN clause contracted in 2020 by Investor A for $1M.
Let's also consider that in 2021, Investor B has contracted a SAFE with a $4M valuation with the same company for $500K.
As the terms of Investor B's SAFE are more favorable than those of Investor A, the company has a legal obligation to notify Investor A, who will have the right to requalify their SAFE to obtain a better valuation cap of $4M.
What are the Key Clauses in SAFE Agreements ?
As their name suggests, SAFEs are simple agreements based on a universal model. However, each investment is unique and each investor/founder should be aware of the main clauses protecting their interests in the event of a SAFE investment.
Let's take a look at the main SAFE clauses
Pro-rata Rights
Pro-rata rights allow the SAFE investor to maintain their ownership percentage in subsequent funding rounds by purchasing additional shares.
The mechanism is as follows: if the company issues new shares, the investor with pro-rata rights has the option to buy enough shares to maintain the same ownership percentage.
Conversion Trigger Events
Different events can trigger the conversion of a SAFE into equity, ensuring the investor receives shares under predetermined conditions.
Conversion typically occurs upon the first of the following events :
- Equity Financing: Conversion during the next priced equity round, allowing the SAFE to convert into shares at the agreed terms based on the new round’s valuation.
- Acquisition: Conversion based on the acquisition price if the company is acquired, enabling SAFE investors to receive shares equivalent to their investment at the acquisition valuation.
- IPO: Conversion if the company goes public, with the SAFE converting into shares at the IPO price, giving investors publicly tradable equity.
- Change of Control: Conversion upon a significant shift in ownership or management, such as a major sale of shares or a merger, ensuring SAFE investors receive equity in the newly structured company.
- Dissolution or Liquidation: Conversion to ensure investors receive equity before asset distribution in the event of liquidation, prioritizing SAFE holders in the payout hierarchy to secure their investment.
Liquidation Preferences
Liquidation preferences specify the order and amount of payments to SAFE holders in the event of liquidation, acquisition, or other liquidity events.
This clause ensures that SAFE investors are compensated before common shareholders if the company is sold or liquidated.
The mechanism is as follows:
- If a liquidation event occurs, the SAFE holders receive their investment back before any distribution to common shareholders. The payout can be a fixed sum or based on a formula outlined in the SAFE agreement.
- After the SAFE holders are compensated, any remaining assets are distributed to the other shareholders.
Information Rights
Information rights grant the SAFE investor access to certain financial and operational information about the company.
These rights provide transparency and keep investors informed about the company's performance and financial health.
The commitments of the parties are :
- The company is required to provide regular financial statements, such as quarterly and annual reports, to the SAFE investors.
- SAFE investors can request additional information as specified in the SAFE agreement.
- The investors agree to keep the received information confidential to protect the company’s sensitive data.
Expiration or Termination Conditions
Expiration or termination conditions outline the circumstances under which the SAFE expires or can be terminated.
This clause clarifies the status of the SAFE if no conversion event occurs within a certain timeframe or under specific conditions.
Several scenarios can be covered by the contract :
- The SAFE may have an expiration date, specifying when it will expire if not converted.
- The agreement can also terminate by mutual agreement between the company and the investor.
- Specific conditions, such as failure to raise a new round, can trigger the expiration or termination of the SAFE.
Amendment Clause
This clause ensures that no unilateral changes can be made without the consent of both parties.
How it works:
- Any amendments to the SAFE agreement require written consent from both the company and the investor.
- The process for proposing and approving amendments is outlined in the agreement.
- Changes are documented and signed by both parties to formalize the amendment.
Governing Law
The governing law clause identifies the legal jurisdiction that will govern the interpretation and enforcement of the SAFE. This clause provides a legal framework for resolving disputes and interpreting the agreement.
- The SAFE specifies the state or country whose laws will apply to the agreement.
- Legal disputes are resolved according to the laws of the specified jurisdiction.
- Both parties agree to abide by the legal standards of the chosen jurisdiction, ensuring clarity and consistency in legal proceedings.
Pre-money SAFE vs post-money SAFE : What is the difference ?
The main difference between pre-money SAFE and post-money SAFE is the way the ownership rate of the SAFE investor is calculated when the cap valuation is applicable. In the pre-money SAFE, the SAFE investors dilute each other, whereas in the post-money SAFE, each SAFE investor knows their minimum percentage of ownership at conversion.
When the first version of SAFE, the pre-money SAFE, was created by Y Combinator in late 2013, startups were raising smaller amounts of money in advance of raising a priced round of financing (e.g., a series A). What was mainly sought was a simple and fast way to get that first money into the company, and the concept was that SAFE holders were simply early investors in that future round. But early-stage fundraising evolved in the following years, and now startups are raising much larger amounts of money as a first "seed" round of financing. Once the SAFEs had been used for these wholly separate rounds of financing, rather than as "gateways" to subsequent rounds, the initial contract had to be adapted.
The post-money SAFE was created in 2018. It gives the possibility to calculate immediately and precisely how much ownership of the company has been sold, which protects the interests of both SAFE investors and founders.
Let's take a look at two situations to see the difference between SAFE pre-money and SAFE post-money.
Case of Two Pre-Money SAFEs:
Let's consider a pre-money SAFE with a $5M valuation cap contracted in 2020 by Investor A for $1M and by Investor B for $500K. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $10M.
What percentage of the company will be owned by the SAFE investors?
In the case of a pre-money SAFE, the steps to follow are different from those in the “SAFE with Valuation Cap” section:
- Determine the valuation for SAFE conversion: The lower of the financing round valuation or the valuation cap is used for the SAFE conversion. Here, the valuation cap ($5M) is lower than the valuation of the financing round ($10M). The valuation for SAFE conversion is $5M.
- Infer the SAFE Investor PPS based on the Valuation: The price per share paid by the SAFE investors is the pre-money valuation / the number of company shares before SAFE conversion, or $5M / 1M = $5.
- Calculate the number of shares of each SAFE investor: The number of shares of each investor is the amount invested by the SAFE investor / the SAFE investor PPS, or $5. Number of shares of Investor A = $1M / $5 = 200K shares. Number of shares of Investor B = $500K / $5 = 100K shares
- Calculate the total number of shares after SAFEs conversion: The total number of shares after conversion is the number of company shares before SAFE conversion + the number of shares of each investor, or 1M + (200K + 100K) = 1.3M shares.
- Calculate the % ownership of of each SAFE investor:The % ownership of the SAFE investor is the number of shares of the SAFE investor / the total number of shares after SAFEs conversion.% ownership of Investor A = 200K / 1.3M = 15.4%% ownership of Investor B = 100K / 1.3M = 7.7%
Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.
How would Investors A and B be affected if there had been another investor?
Let's consider another SAFE investor, C, who contracted another $1M pre-money SAFE under the same conditions as A and B.
Under these conditions, steps 3, 4, and 5 will have to be reviewed.
Number of shares of SAFE investors:
- Number of shares of Investor A is unchanged: 200K shares
- Number of shares of Investor B is unchanged: 100k shares
- Number of shares of Investor C = $1M / $5 = 200K shares
Total number of shares after SAFEs conversion: The new total number of shares is 1M + (200K + 100K + 200K) = 1.5M shares
% ownership of SAFE investors :
- % ownership of Investor A = 200K / 1.5M = 13.3%
- % ownership of Investor B = 100K / 1.5M = 6.7%
- % ownership of Investor C = 200K / 1.5M = 13.3%
The impact of SAFE investor C has therefore been to reduce the ownership rate of Investor A from 15.4% to 13.3% and of Investor B from 7.7% to 6.7%.
We can see that in the case of pre-money SAFEs, SAFE investors influence each other's ownership rates.
Case of Two Post-Money SAFEs
Let's consider a post-money SAFE with a $5M valuation cap contracted in 2020 by Investor A for $1M and by Investor B for $500K. Before SAFE conversion, the company had 1 million shares.
What percentage of the company will be owned by the SAFE investors?
In the case of a post-money SAFE, the minimum percentage of SAFE investors can be calculated immediately when the SAFE is contracted using the valuation cap:
The percentage of shares guaranteed to SAFE investors is the amount invested by the SAFE investor / the post-money valuation cap.
% ownership of SAFE investors:
- % ownership of Investor A = $1M / $5M = 20%
- % ownership of Investor B = $500K / $5M = 10%
The SAFE investors' effective holding percentage is calculated at the time of the next equity round on the basis of the lowest valuation between the valuation cap and the valuation of the financing round.For more details, see the section "SAFE with Valuation Cap."
NB : This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.
How would investors A and B be affected if there had been another investor?
Let's consider another SAFE investor, C, who contracted another $1M post-money SAFE under the same conditions as A and B.
In the case of post-money SAFEs, the percentage of shares guaranteed to investors A and B remains the same.
% ownership of SAFE investors:
- % ownership of Investor A = $1M / $5M = 20%
- % ownership of Investor B = $500K / $5M = 10%
- % ownership of Investor C = $1M / $5M = 20%
We can see that in the case of post-money SAFEs, SAFE investors don't influence each other's ownership rates.
What is a BSA AIR and how does it differ from the SAFE?
The BSA AIR is the French equivalent of the SAFE; it stands for Bon de Souscription d'Actions par Accord d'Investissement Rapide. Like its American counterpart, the BSA AIR provides a future right to equity, its conversion price is indexed to the following equity round and can include a discount, a valuation cap, and/or a valuation floor.
Although similar to the American SAFE, the BSA AIR was developed in a different jurisdiction and therefore contains some notable differences that everyone should bear in mind before using it:
- If nothing happens, the BSA AIR is still converted
Unlike the SAFE, the BSA AIR offers conversion of the investment into shares on a specific date if no triggering event, such as a fundraising, occurs before that date. This conversion is calculated on the basis of an alternative valuation, which may correspond to the Valuation Cap, Valuation Floor, or a median value. In the basic model proposed by its creator, Sacha Benichou, an attorney at the Paris Bar, this date is set at 24 months after the subscription date and sets the alternative exit value at the median value between the Valuation Cap and the Valuation Floor.
- The BSA AIR allows transfer of ownership
Unlike the SAFE, where transfer of ownership is only possible by mutual agreement between the investor and the company, the right to transfer the BSA AIR is set out in the terms of the contract and may be authorized or prohibited according to the wishes of the contracting parties.
- The BSA does not offer preferential liquidation
In the event of an exit (buyout, IPO or SAFEguard procedure), the BSA-AIR does not include a preferential liquidation clause, unlike the SAFE. This clause entitles the investor to priority repayment, ahead of the other shareholders.
