SAFE (or simple agreement for future equity) notes are documents those start-ups often use to raise seed capital. Essentially, a SAFE note acts as a legally binding promise to allow an investor to purchase a specified number of shares for an agreed-upon price at some point in the future.
SAFE notes are a type of convertible security, while convertible notes are a form of debt that can convert into equity once certain milestones are met. Because of this, convertible notes usually have a maturity rate and an interest rate.
How did SAFE notes work?
For start-ups in the initial stage, there is typically very little data, making it difficult to assign the company any value. SAFE notes allow you to postpone your company’s valuation until a later date with the following steps when raising funds through SAFE notes:
- An investor provides seed money in exchange for an equity stake in future.
- The company uses the investment to build the business.
- Post progress of business, find another investor with post-money valuation.
- Calculate the company’s new price per share.
- Convert the SAFE note into the applicable number of shares in the company and distribute them to the SAFE investor.
Key Elements in a SAFE Note
- Discounts: SAFEs sometimes apply discounts, usually between 10% and 30%, on future converted equity. This means that the investor will be able to purchase shares at a discount on future financing.
- Valuation Caps: Another way for the investor to get a better price per share than future investors are through a valuation cap. Valuation caps are a term in SAFE notes that establish the highest price or cap that can be used when setting the conversion price.
- Most-Favoured Nation Provisions: Where there are multiple SAFEs, this term requires that the company notify the first SAFE holder of the terms for the subsequent note. If the first SAFE holder finds the second SAFE’s terms to be more favourable, they can ask for the same terms.
- Pro-Rata Rights: Allow investors to invest extra funds so that they can keep their percentage of ownership during a future equity financing.
An investor has four options while investing in start-ups through SAFE note
- A valuation cap, but no discount
- A discount, but no valuation cap
- A valuation cap and a discount
- No valuation cap and no discount
|Particulars||Discount rate||Valuation cap||Discount rate & Valuation Cap|
|SAFE investment||$ 1 Mn||$ 1 Mn with a valuation cap of $ 2 Mn||$ 1 Mn with a valuation cap of $ 2 Mn|
|Funds infused by New Investor||$ 1 Mn||$ 1 Mn||$ 1 Mn|
|Value per share of New Investor||$ 1||$ 1||$ 1|
|Revised Valuation||–||$ 8 Mn||$ 8 Mn|
|Discount rate||–||0.75[$2 Mn / $8 Mn = 0.25 then 1 – 0.25 = 0.75]||0.67[$2 Mn / $6 Mn = 0.33 then 1 – 0.33 = 0.67]|
|Revised price for conversion||–||0.75[1 * 0.75]||Either of 0.5 or 0.75|
|Number of shares New Investors to get||1 Mn shares||1 Mn shares||1 Mn shares|
|Number of shares SAFE Investor to get||2 Mn shares||1,333,333 shares||2 Mn shares (possible to opt for 0.5 which is more favourable|
As a start-up, finding funding is often one of the very first challenges that one will face. SAFE notes, while still new, provide an excellent opportunity for start-ups to develop business without increasing overheads with interest payments.
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