A SAFE note, or Simple Agreement for Future Equity, is a contract that allows investors to invest in a startup now and receive company shares later

Now, 100% of our clients raise pre-seed capital through SAFEs, replacing convertible notes as the go-to early-stage investment instrument. This popularity makes sense: SAFE drastically simplifies early-stage funding by pre-setting clear terms like discounts and caps, cutting the trouble of pinpointing a company’s exact value.

Here, you’ll learn:

  • What SAFE notes are
  • The mechanics of investment, valuation caps, and conversion
  • The difference between SAFE vs. convertible notes
  • How startups can leverage SAFE notes in fundraising

So, what is a SAFE note?

A SAFE note, or Simple Agreement for Future Equity, is an investment contract commonly used by startups to secure funding from early-stage investors

Established by Y Combinator in late 2013, SAFE has become the norm for early-stage funding for almost all Y Combinator startups. Over time, SAFE Y Combinator has spread beyond the community due to its founder-friendly nature, simplicity, and efficiency.

SAFE note offers flexibility for both parties. 

  • Startups receive funding without a fixed valuation upfront by offering investors a set of terms, such as valuation caps or discounts — the reward for early investors for the risk they have taken.
  • Investors gain the potential to convert their investment into company shares (equity) later on.

While SAFE notes offer quicker and easier fundraising, they can dilute founders’ ownership if the startup experiences significant growth.

Types of SAFE notes

There are four general types of SAFE notes. Choosing the right one depends on the startup’s stage, negotiation leverage, and investor risk tolerance. 

SAFE: Valuation cap, no discount
Gives investors the most protection and ensures they buy shares at a fixed price without an extra discount.

SAFE: Discount, no valuation cap
The investor gets a discount on the share price, but without a valuation cap, the discount’s advantage may lessen if the startup performs exceptionally well.

SAFE: Valuation cap and discount
Combines a share price discount with a maximum valuation limit, balancing protection and potential gain for the investor.

SAFE: MFN, No valuation cap, no discount
The investor receives top terms that match the best offer in a future round without a cap or upfront discount.

Consult with a lawyer to ensure that the SAFE note reflects the agreed-upon terms. 

Note: In 2021, Y Combinator removed the ‘SAFE: Valuation cap and discount’ from its website without explanation. Yet it remains popular for its straightforward, off-the-shelf use, occasionally allowing investors to modify the terms with legal guidance.

How does a SAFE note work?

The SAFE note is like an IOU for future shares—investors fund it and later acquire ownership in the company at a price determined by the agreed-upon terms. The specific type of SAFE note (valuation cap, discount, etc.) determines the final ownership stake based on the company’s performance.

Here’s a detailed breakdown of the mechanics:

  1. Investment: An investor contributes capital to the startup.
  2. Conversion Trigger: The SAFE specifies a triggering event that converts the investment into equity. This event usually occurs during a subsequent funding round when the startup raises SAFE capital at a higher valuation.
  3. Conversion Mechanism: There are two primary mechanisms for conversion:

a.) Discount Rate: Outlines the ‘discount’ investors will receive on the priced round when it converts. The higher the discount, the less advantageous the deal is for founders because investors receive more equity.

Discount Rate Conversion Mechanism SAFE note

b.) Valuation Cap:  Outlines the maximum price at which it will convert. The lower the valuation cap, the less advantageous the deal is for founders because investors can convert their notes into more equity in the company.

Valuation Cap Conversion Mechanism SAFE note

4. Equity Ownership: Upon the triggering event, the investor’s SAFE converts into the startup’s common stock based on the predetermined conversion mechanism.

What’s better for founders: Discount or cap?

Founders prefer uncapped and discounted SAFEs because they reward early-stage investors and avoid setting a random value for the startup. Some investors won’t invest without a cap, but it depends on bargaining power. In the early stages, an uncapped SAFE suggests attractiveness and negotiation power. If there aren’t many eager investors, founders negotiating a cap should ensure it’s reasonable and higher than what the company could get in a priced equity round.

When to opt for SAFE notes?

  • When simplicity and speed are vital:

The standardized terms of SAFE notes speed up the fundraising process and reduce legal costs, making them an appealing choice for startups seeking to close funding rounds quickly.

  • When valuation is uncertain:

SAFE Notes delay valuation until a future financing round, allowing both founders and investors to avoid setting a specific valuation at the early stage.

  • During the early stages of development: 

They provide a straightforward and friendly way to raise capital without getting into complex valuation negotiations.

SAFE notes benefits for startups

SAFE Notes speed up the funding process by avoiding lengthy negotiations and valuations. They also give founders flexibility by avoiding shareholder voting and control issues, allowing them to focus on running their company smoothly.

SAFE notes benefits for investors

Investors benefit from quick access to early-stage through SAFE notes investments, as they offer potential equity on favourable terms during a priced equity round. 

Predefined conversion terms, such as valuation caps and discounts, allow investors to exploit these opportunities.

How do you efficiently issue SAFE notes in your startup?

SAFE notes can be a great way to secure funding for your early-stage startup. Here’s a simplified breakdown of the process:

1. Define the terms:

– Figure out how much capital you need and who you’ll target as investors (angel investors vs. venture capitalists).

– Determine the valuation cap (maximum price for investor shares), discount rate (investor discount on share price), and triggering event (when SAFE notes convert to equity, usually a later funding round).

2. Create the SAFE notes agreement:

– Use online templates or consult a lawyer to tailor the agreement to your needs.

– Clearly define the key terms above and other provisions like information and voting rights.

3. Issue notes and collect funds:

– Negotiate terms with potential investors once the agreement is finalized.

– Upon reaching an agreement, both parties sign the SAFE notes, and the investor sends the funding.

– Keep clear records of each SAFE note issued.

4. Convert to equity:

– The SAFE note converts into company shares when the triggering event happens.

– The conversion price depends on the valuation cap and discount rate defined in the SAFE equity agreement.

SAFE vs. Convertible notes: What is the difference?

While both SAFEs (Simple Agreements for Future Equity) and convertible notes offer financing options for early-stage startups, their legal structures and investor protections differ. 

Convertible notes are debt instruments with maturity dates and interest rates, potentially burdening startups with repayment obligations. 

In contrast, SAFE notes are simple, debt-like instruments that convert into equity during future financing events, eliminating the need for repayment and interest accrual. 

Note: Choose SAFE if you want a more straightforward agreement with no interest payments and are okay with figuring out the price later. Choose Convertible notes if you want fast and flexible funding. They offer the option to skip valuation, convert to ownership later, and receive repayment protection.

Convertible note vs SAFE note
Convertible note vs SAFE note 2

FAQ

Can we discuss SAFE note terms with investors?

Yes, the terms of a SAFE can and should be negotiated. Avoid SAFEs with a low valuation cap and a high discount rate. SAFEs structured like this come with a significantly higher cost of capital than those with a high valuation cap or a low discount rate.

Does every startup benefit from using a SAFE note?

SAFE notes are great for various startups, especially early-stage ones. They’re simple, flexible, and help avoid interest payments. However, they offer less protection for investors who prefer Convertible Notes. Talk to a lawyer to see if a SAFE note is right for your startup’s growth.

What are the alternatives to SAFE notes funding?

SAFE notes are just one of many options for startups. Consider convertible notes (debt to equity later), equity financing (selling ownership), or revenue-based financing (funding based on sales).

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Anastasiia

CONTENT WRITER

Hey there! I'm Anastasiia, a Content Writer at Waveup. With my marketing expertise and storytelling magic, I turn complex data and industry insights into your startup playbook, making the business world a breeze for you! At Waveup, I work with brilliant folks who make insights a never-ending flow. So, join, read, and enjoy!