Startups & Entrepreneurs: A Founder's Toolkit - Understanding the Post-Money SAFE

While both instruments have some similar characteristics, convertible notes have a long history and consist of debt terms generally understood by a broad audience. On the other hand, SAFEs have some unique features, typically requiring a more in-depth discussion. Below we discuss those features. In future articles, we will discuss the key elements of convertible notes and compare the two more in-depth.

Overview

SAFEs are convertible instruments that, similar to convertible notes, will convert the holder’s investment amount into equity of the issuing company upon the occurrence of a triggering event. One key feature shared between convertible notes and SAFEs that make them attractive to early-stage founders is their ability to provide a method of fundraising without the burden of attempting to value a company in its infancy.

Conceptually, by removing the interest rate and maturity dates, SAFEs were created to establish a more streamlined and cost-efficient fundraising method over convertible notes. While such terms are critical aspects of traditional debt instruments, return of principal plus interest accrual is not a vital goal of the high-risk, high-return early-stage investment thesis.

While SAFEs have been around since Y Combinator released them in 2013, widespread use arose in 2018-2019. The original SAFE formulation was a “pre-money” SAFE, but the most popular version today is the “post-money” SAFE. Therefore, we focus on the “post-money” SAFE in this article. However, for background, the key difference between the two is the point at which the equity conversion is determined.

Key Features of “Post-Money” SAFEs

• Conversion. SAFEs convert into equity of the issuing company upon the company’s first equity round. Typically, a Series Seed or Series A financing.

• Discount Rate. SAFEs often include a discount rate whereby the price per share that the SAFE converts is less than the price per share paid by the “new money” investors. This discount rate is typically between 15-25% of the price per share paid by the new investors, with 20% being the most common discount.
• Valuation Cap. The valuation cap establishes a ceiling price for the SAFE equity conversion by setting a maximum value at which the SAFE converts. For example, suppose the post-money valuation of the newly priced round is $10 million, and the SAFE has a valuation cap of $6 million. In that case, the SAFEs will convert based on the $6 million valuation, and the new money will be invested at the $10 million valuation.

If a SAFE has both a discount and valuation cap, then the SAFE converts under the term that gives the investor the greatest discount to the new equity round price. Investors are not entitled to take advantage of the discount and valuation cap (i.e., no double-dipping).

• Company Sale. Suppose the issuing company is sold before a priced equity round. In that case, the SAFE is treated like non-participating preferred stock (i.e., the investor is entitled to the greater of (i) a return of its investment amount and (ii) the amount it would have received had it originally purchased common stock, with such common stock being priced utilizing the same discount and valuation cap mechanics as apply in the context of an equity round conversion).
• Most Favored Nation (MFN). If both the company and investor want to delay conversion term discussion, then they can use an MFN form of SAFE, which provides that such SAFE will receive any favorable terms (i.e., valuation cap and discount) given to future SAFE investors. This form is most often used by early investors who anticipate the terms of future SAFEs to be dictated by later-stage investors.
• Pro Rata Rights. By default, the “post-money” SAFE does not grant an investor a right to purchase its pro rata share of securities sold in the equity financing. But, often, these rights are presented in a side letter. The advantage to SAFE investors in having these rights is that they can maintain their ownership percentage in the company post the priced equity round.

Conclusion

This article contained a summary of the key features of the “post-money” SAFE. While these instruments are designed for fast and cost-efficient investments, they are not suitable for every company, investor or deal. In addition, there are additional considerations in using SAFEs that are beyond the scope of this article.

Author Jason Acevedo is a partner in the Venture Capital & Emerging Growth practice group in the Corporate and Securities Department at Klehr Harrison.

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