Demystify SAFE

Simple Agreement for Future Equity (SAFE) was introduced by YC to help startups for early-stage fundraising.

However, the legal and financing terms used in the agreement can be overwhelming to founders that are not familiar with the process. I am gonna use Safe: Valuation Cap, no Discount as an example to clarify a little bit.

The first thing you need to understand is that the agreement is for future equities. Meaning that you don’t need to go through the complicated process of getting all other investors to sign documents or issuing new stocks to the new SAFE investor. This is also why SAFE is becoming the industry standard.

The second thing you should know is that there are 3 major types of events that will “activate” the agreement and lead to certain implications. Then the agreement will be terminated automatically.

Equity Financing

In human words, this refers to a formal round of fundraising in exchange of stocks. When it happens, the SAFE investor will receive some stocks as well. The amount equals to the valuation divided by the SAFE investment. The valuation will be chosen as the smaller of the formal round valuation and the SAFE valuation (i.e. Post-Money Valuation Cap).

For example, if the SAFE valuation cap is $10M and the purchase amount is $1M, then the SAFE investor will receive 10% of the company's equity if a formal round of funding is closed at a valuation of $50M. However, if the formal round of funding is closed at a valuation of $5M, the SAFE investor's equity stake will increase to 20%.

Liquidity Event

This usually happens when the company IPOs or is acquired by other companies. When such events happens, instead of receiving stocks, the SAFE investor receive some money.

The amount is determined by the valuation when the event happens. If the valuation is smaller than the SAFE valuation, the SAFE investor gets their money back, fully. Otherwise, the amount will increase in proportional to the valuation increase.

As an illustration, if the pre-money valuation cap of the SAFE is set at $10M and the purchase amount is $1M, then the SAFE investor is entitled to $5M when the company is acquired with a $50M valuation.

Dissolution Event

In the event of a company closure initiated by the founders, SAFE investors are entitled to receive a full return of their investment.

Nevertheless, the investors' return will be contingent upon the amount of funds the company has remaining. If the company lacks sufficient funds, they will receive only a fraction of their initial investment, the magnitude of which will be determined by the "Liquidation Priority" as stipulated in Section 1(d).

In essence, investors have a higher preference than founders because commonly, founders own Common Stock while investors own Preferred Stock or a SAFE.

If, for instance, the SAFE valuation cap is $10M, and the purchase amount is $1M, with an additional investor who owns 10% Preferred Stock, then the remaining funds of $100 upon dissolution should yield $50 to the SAFE investor.

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