Since its creation in 2013, the usage of the SAFE has proliferated as an early-stage financing instrument and is now used in every single place from Silicon Valley VC offers to on-line crowdfunding rounds. Nonetheless, not all SAFEs are created equal.
The SAFEs utilized in VC rounds and in angel SPVs may be fairly completely different from SAFEs on crowdfunding platforms. Even SAFEs between crowdfunding platforms (e.g. Republic vs. Wefunder) can have key variations that buyers ought to pay attention to.
On this article, we’ll assessment the fundamentals of the SAFE and focus on key variations between crowdfunding SAFEs and conventional SAFEs.
What’s a SAFE?
A Easy Settlement for Future Fairness (SAFE) is a sort of early-stage funding safety that converts to fairness at a specified conversion occasion sooner or later. It’s roughly equal to a Convertible Notice, solely with out a maturity date or rate of interest.
Historical past of the SAFE
The famed accelerator Y-Combinator originated the pre-money SAFE in 2013. Its use was adopted in Silicon Valley and shortly unfold all through the world. At the moment, SAFEs are used in every single place from Silicon Valley to on-line crowdfunding portals, although particular deal phrases nonetheless range.
In 2018, YC up to date their boilerplate SAFE to be a “post-money” SAFE, which signifies that it now converts primarily based on post-money valuation as a substitute of pre-money valuation. One other notable replace included including in provisions that explicitly deal with the SAFE as fairness for functions of taxes beneath IRC Part 1202.
The most recent post-money YC SAFE templates may be discovered right here; nevertheless, many SAFEs on crowdfunding portals nonetheless use the pre-money SAFE as of late 2021. Additionally, conversion triggers in crowdfunding SAFEs are normally completely different than these present in the usual YC SAFE utilized in accredited offers, as we’ll focus on beneath.
SAFE Deal Time period Fundamentals
The 2 most vital deal phrases related to a SAFE are its low cost fee and valuation cap.
Some examples of SAFE phrases embody:
- SAFE with $5 million valuation cap and a 15% low cost
- Uncapped SAFE (i.e. no valuation cap) with a 25% low cost
- SAFE with a $15 million valuation cap and no low cost
As you’ll be able to see, each the low cost fee and the valuation cap will range between every SAFE. Moreover, each phrases are non-obligatory, so a SAFE might have each, or only one or the opposite (not often will a SAFE have neither).
SAFE Conversion Examples
A SAFE will convert to fairness on the higher of both the valuation cap or the low cost fee.
Let’s say you put money into a SAFE with a $5 million valuation cap and a 20% low cost. Listed here are some completely different conversion examples.
- If the startup raises a follow-on financing spherical at a $6 million post-money valuation:
- The valuation cap can be $5 million.
- The 20% low cost can be at an efficient $4.8 million valuation ($6M*0.8 = $4.8M).
- Because the low cost fee ($4.8 million) is best than the valuation cap ($5 million), your SAFE would convert beneath the 20% low cost at an efficient valuation of $4.8 million.
- So if present buyers within the $6 million post-money spherical have been investing at $1 per share, SAFE buyers would get a $4.8/$5*1 = $0.96 per share.
- If the startup raises a follow-on financing spherical at a $10 million post-money valuation:
- The 20% low cost can be an efficient $8 million valuation.
- Because the $5 million valuation cap on the unique SAFE is a greater deal for buyers, the SAFE would convert on the valuation cap of $5 million.
- So if present buyers within the $10 million post-money spherical have been investing at $1 per share, SAFE buyers would get a $5/$10*1 = $0.50 per share.
Low cost charges will give a greater conversion worth if the follow-on spherical is much like the prior spherical (as much as the quantity of the low cost). For rounds and exits which have a lot steeper will increase in valuation, the valuation cap will give the extra favorable phrases.
When do SAFEs Convert to Fairness?
A SAFE converts to fairness at a specified conversion occasion sooner or later. Typical conversion eventualities might embody an exit (e.g. acquisition, IPO, and so forth.) or a future financing spherical, akin to a Collection A spherical after an preliminary Seed spherical.
Particularly on crowdfunding portals, conversion triggers will range from SAFE to SAFE. Buyers ought to all the time learn the subscription settlement for every deal in its entirety.
The three kinds of conversion occasions usually laid out in a SAFE embody:
- Fairness Financing Occasion (e.g. follow-on financing spherical – e.g. Collection A, Collection B, and so forth.)
- Liquidity Occasion (e.g. if there’s a merger, acquisition, IPO, or different liquidity occasion previous to the conversion of the SAFE, which will set off a conversion to fairness)
- Dissolution Occasion (e.g. the corporate shuts down operations)
Changing into Frequent vs. Most popular Fairness
Whereas the usual Y-Combinator SAFE converts to Most popular Fairness, crowdfunding SAFEs — akin to these used on Republic and Wefunder — will range by way of whether or not they convert to Frequent Inventory or Most popular Inventory.
Frequent Inventory is the kind of fairness held by founders and staff of an organization, whereas Most popular Inventory is the kind of fairness usually held by buyers. Amongst different variations, Most popular Inventory usually comes with a liquidation choice (e.g. 1X, 2X, and so forth.), which means Most popular shareholders will likely be paid again previous to Frequent shareholders ought to the corporate be liquidated.
Each Frequent and Most popular shareholders are paid after debt-holders and collectors, and that’s provided that there may be something left to be paid.
SAFEs that Convert to Shadow Collection Shares
Some crowdfunding SAFEs, such because the Republic Crowd Secure, might convert to “Shadow Collection” shares.
This primarily signifies that Crowd Secure holders will obtain the identical class of shares (e.g. Frequent or Most popular), solely these shares can have restricted voting and knowledge rights.
What Occurs When a SAFE Firm Fails?
If a startup fails, buyers will likely be paid out primarily based on the “dissolution occasion” provisions of the SAFE phrases and the “liquidation precedence” order.
Basically, buyers mustn’t anticipate to obtain any capital again when an organization fails, for the reason that proceeds of the failure, if any, will first be paid to debt holders.
In the usual Y-Combinator post-money SAFE phrases, a SAFE is paid out:
- junior to funds of excellent indebtedness and creditor claims,
- on par with different SAFEs and Most popular Inventory, and
- senior to Frequent Inventory.
That is usually discovered beneath the “Liquidation Precedence” part of the SAFE phrases.
Abstract of Crowdfunding SAFE Variations
Now that we’ve got a stable understanding of the deal phrases and fundamentals of the SAFE, we are able to assessment the commonest variations between crowdfunding SAFEs and conventional SAFEs:
- Crowdfunding SAFEs might have non-obligatory conversions: in some crowdfunding SAFEs (akin to Republic’s Crowd Secure), shares convert on the subsequent fairness financing spherical on the discretion of the issuer (i.e the startup). Whereas most conventional SAFEs are pressured to transform on the subsequent certified financing spherical, many crowdfunding SAFEs give the corporate the choice to both convert to fairness or defer conversion till a later time.
- Whereas this may increasingly sound like a nasty factor for buyers at first, we’ll focus on in a future article why this is usually a win-win for each the corporate and the buyers.
- Crowdfunding SAFEs might convert to Shadow Collection shares: within the Republic Crowd Secure, the SAFE might convert to shadow shares, which suggests the identical class of shares (e.g. Frequent vs. Most popular) as different buyers, however with restricted voting and knowledge rights.
- Crowdfunding SAFEs Investing through an SPV: Once you put money into a SAFE on Wefunder, you’ll usually be investing in a Particular Objective Automobile (SPV). Whereas that is typical for angel buyers on websites like AngelList, this implies you’ll really be investing within the SPV (e.g. “Firm X, a Collection of Wefunder SPV LLC”), and never be immediately investing within the firm itself.
- Investing in an SPV might have potential tax implications (as a result of the SPV is an LLC). Moreover, investing in an SPV might have implications by way of the potential future liquidity of that funding attributable to problems when itemizing SPV shares on a secondary market.
- Many Crowdfunding SAFEs are nonetheless Pre-Cash: whereas the usual Y-Combinator SAFE was modified to transform primarily based upon post-money valuation in 2018, most of the SAFEs used on crowdfunding websites as we speak are nonetheless utilizing pre-money valuation for the conversion worth.
- Some Crowdfunding SAFEs might have repurchase rights: one thing that the majority VCs and angel SAFEs would by no means have is a “repurchase rights” or “redemptive clause”. These phrases enable the corporate to buyback SAFE buyers on the firm’s discretion, which generally occurs if a later-stage VC desires to “clear up” the cap desk (i.e. get extra management and possession for themselves) or when the corporate is doing effectively and desires to purchase out early buyers. As we’ll focus on in a future article, buyers ought to keep away from SAFEs with these phrases. These phrases put the corporate’s greatest pursuits at odds with that of the buyers’.
- The excellent news is that I’ve not seen any SAFEs just lately with these repurchase phrases (though I’ve seen some Frequent Inventory choices on some platforms with repurchase rights, so watch out!). It appears that evidently crowdfunding portals have realized that these repurchase rights usually finish poorly for buyers and are utilized by issuers who won’t have their crowdfunding buyers’ greatest pursuits at coronary heart.
In our subsequent article, we’ll dive even deeper into SAFEs and discover the frequent query of whether or not SAFEs are unhealthy for buyers or not.