One of the easiest and cheapest ways to invest in early-stage companies is through a Simple Agreement For Future Equity (SAFE). The purpose of a SAFE is to enable startups to avoid wasting time and money preparing a detailed valuation report. SAFEs are simple to use and perform their functions at a low cost. They may be used by both individual investors and groups of investors with equal success. Here’s a helpful guide for startups on the essential things to know about SAFE:
- Know What Is Simple Agreement For Future Equity
For a contract that allows the investor the right to convert the investment into future stock, a SAFE is a cash investment that’s made use today. It’s not a loan and doesn’t have any rights or voting rights under state laws.
You can’t repay a loan using SAFEs since they don’t have an interest rate or a maturity date. A SAFE isn’t a kind of equity, since it doesn’t confer any ownership or voting rights, whether standard or preferred, under applicable state legislation. The corporation signs a three- to five-page SAFE contract and grants the investor specific rights in exchange for the investor’s monetary investment.
A startup firm may employ a finance arrangement known as SAFE to secure seed funding. Some see it as a better option for founders than convertible notes.
You may rely on start-up-focused partners such as Cake to help you complete your transactions from beginning to end.
- Know How SAFE Works
SAFE notes are still more straightforward than convertible notes in their recent incarnation. However, they’re still more complicated than convertible notes, SAFEs were designed to be utilized directly in startup investment rounds without the need for adaptation.
The pre-money and post-money valuations of SAFEs are interchangeable, unlike convertible notes. They derive most of their gains by taking risky bets and receiving high returns on equity for early-stage investment and transactions done by angel investors.
A value limit and a discount rate apply when SAFE notes are converted into stock in the next equity round. It’s not that they don’t have advantages for entrepreneurs, but they don’t necessarily appeal to investors.
You should note that both parties sign a SAFE after the conditions are agreed upon, and the agreed-upon money has been sent to the firm. There are applicable terms and restrictions to use the money. Once the SAFE agreement specifies an event that triggers the conversion, the investor doesn’t get equity (SAFE preferred stock).
As long as your business continues to develop and succeed, it’s not in the best interests of your company or your investors to set a deadline for the next round of equity financing. Please note that there’s a risk that an early-stage investor who’s obsessed with terminologies, like interest rates and maturity dates might be seen suspicious. By now, it’s safe to say that most informed investors you come into contact with are utilizing SAFEs.
- Know What To Factor In as Founder
Startups usually use SAFEs to raise money, and they’re also beneficial for founders since they don’t have to worry about running out of funds once they reach their target. As a rule, only three things may be negotiated in the SAFE agreement with investors: the value limit, the discount, and the financing threshold, which the SAFE would convert in the calculation.
Convertible loan notes are similar to SAFE instruments, they provide rights to a particular investor for future stock in a business. However, SAFE tools are considered as more founder-friendly alternative than convertible loan note. When it comes to convertible loan notes, owners may concentrate on developing their firm without worrying about debt or funding deadlines since there are no maturation dates or accumulation of interest.
- Know What To Consider Before Investing
Investors, like founders, benefit from the SAFE investment’s simple and standard form documentation, which lowers negotiating time and enables investors to make judgments swiftly. Potential investors prefer SAFE instruments, because they get future shares at a lower price when an investment round or liquidity event happens. Investors can turn their money into a stock at a particular moment. However, there are risks in investing in a SAFE, it could get canceled, the company wasn’t sold, and investors can’t convert it into equity.
- Importance of SAFE To Startups
Entrepreneurs mainly utilize |SAFEs to raise capital. They are significant to a startup’s success, because they don’t accumulate interest like a loan. They’re straightforward to develop and administer. Lastly, they provide more flexibility in the company’s ability to obtain capital.
Takeaway
A SAFE is a simple and secure method of funding startups, without the traditional expenses and negotiating methods typically associated with more conventional financing. These financing solutions can help startup companies avoid problems that arise when converting their existing loan notes. However, it’s still essential that startups obtain proper legal advice to protect their interests.
