What is a Simple Agreement for Future Equity (SAFE)?

Speed and simplicity matter a lot to early-stage startups. The venture capital and angel investors who take part in seed fundraising rounds appreciate this. It is in these early investors’ best interest to not torture founders with equity financing agreements that require expensive fees and/or a law-school education to sort out. The less time and money it takes for a seed fundraising deal to close, the better for all parties involved. It was in this spirit of mutual benefit (and distaste for legal paperwork) that the Simple Agreement for Future Equity was born.

A Simple Agreement for Future Equity, or SAFE, is a startup financing agreement designed to quickly and efficiently get the first money into a startup. In exchange for investors’ money, the startup offers them the right to future equity in the company. Unlike convertible notes, another common form of early-stage startup financing, SAFEs don't have an interest rate or a loan maturity date.

SAFEs can be a powerful tool in a seed fundraising round, but they’re not the only early-stage funding option founders should consider. In this guide, we’ll cover the basics of SAFEs and compare them to other options so you can choose what works best for you.

• What is a SAFE?
• How SAFEs became a staple of early-stage fundraising
• SAFE vs. other early-stage funding options 
• Pre-money SAFEs vs. post-money SAFEs: What’s the difference? 
• How SAFEs balance the interests of founders and SAFE investors
• Solve the puzzle of early-stage fundraising with Pulley

What is a SAFE?

A Simple Agreement for Future Equity (SAFE) is an agreement made between an early-stage startup and a VC or angel investor. In this type of agreement, which usually takes place during the seed fundraising round, the investor pays money now and receives shares of company stock later. Because they involve converting money to equity at a later date, SAFEs belong to a group of financing options known as convertible securities. (We’ll review some of these options later in this guide.)

Why would a founder be interested in SAFEs as a financing tool? Well, early-stage startup founders face an interesting dilemma. They need money from investors but do not yet have a valuation for their startup — and getting one might be prohibitively expensive or impractical. Furthermore, they want to avoid taking on too much share dilution. With a SAFE, a founder can quickly find the cash they need to grow their startup, all while saving on legal costs and pushing the dilution question forward to the next funding round.

Most SAFE agreements are structured so that the investor receives the shares due to them in the next priced round of financing. (As SAFEs are most typically used in early-stage fundraising, this is usually a seed or Series A round.) The number of shares the investor receives is usually based on the valuation of the company at that time, though some SAFEs have a valuation cap that puts an upper limit on how the shares are valued at the time of conversion.

How SAFEs became a staple of early-stage fundraising

Things tend to change quickly in the world of venture capital, but the SAFE has proven to be surprisingly durable since its launch in late 2013. 

The startup accelerator Y Combinator (YC) initially devised the SAFE based on feedback from YC-backed startups struggling to balance their investors’ interests with their own (typically small) appetite for complexity. The vision was to create a “flexible, one-document security” that cut down on the time and money spent negotiating investment terms. 

The first SAFEs were typically used by founders and investors looking to get deals done as quickly as possible, but simplicity came at the cost of some certainty. Investors in these “pre-money” SAFEs received a promise to be granted shares at the next financing round, but they didn’t know exactly how much of the company they actually owned. 

To alleviate this uncertainty, Y Combinator released the “post-money” SAFE in 2018. This SAFE measures ownership after all the SAFE money is accounted for and thus gives the investor a clearer picture of what percentage of the company they will own once their money is converted into shares. 

We’ll explain some key differences between pre-money and post-money SAFEs below, but both types have advantages over other types of funding options. For one, they help to unlock what Y Combinator’s Paul Graham refers to as “high-resolution fundraising,” in which founders can draft separate agreements with each individual investor, with specific terms that make sense for the type of investor and the level of risk they assume. SAFEs are also so standardized and ready-to-roll that the only thing left to negotiate, in most cases, is the valuation cap for the shares in each agreement.

SAFE vs. other early-stage funding options

Now that you know what a SAFE is, you may be wondering how it compares to other investment methods available to startups and investors. 

These methods can generally be broken down into two types:

• Equity is a unit of ownership in a company, which may come with certain ownership rights and privileges. If you choose to fund via equity, you will need to give up a certain percentage of ownership shares in your company in exchange for money. The benefit here is that you will owe $0 to the investor and get more money to grow your company with. The downside is that you will need to give up 5%, 10%, 20%, or more of your ownership shares in exchange for those funds.
• Debt instruments generally entitle the investor or lender to repayment of the money they put up. They usually come with an interest rate and a maturity date at which the investor/lender is entitled to full repayment. For example, you might secure a 12-month amortized loan from a bank or online lender for $100,000, with a 10% interest rate. You’d end up paying an extra $5,499 in interest on top of the $100,000 principal amount, but the lender wouldn’t own any piece of your company.

Not every funding option fits neatly into these two categories. Convertible notes are debt instruments that offer the ability to get repaid in equity, so they’re a little bit of both.

As you’ve probably guessed, SAFEs fall into the “equity” category. They do not represent a debt to the investor, but rather a promise to the investor to issue equity at a future date. Since a key feature of SAFEs is that they’re convertible, you might think of them as convertible equity (as opposed to convertible debt).

Let’s look at how SAFEs stack up to other funding options typically available to early-stage startups.

SAFE vs. stock

A share of stock represents an ownership stake in a company. Common stock and preferred stock are two types of stock a company can issue, and both types of equity can be present in the same company’s cap table. 

Venture capitalists and angel investors may ask for preferred stock when investing in startups. They often negotiate for this stock to include voting rights and other powers, such as the right to sit on the board of directors. As you might imagine, these negotiations can be time-intensive, laborious, and costly. Another snag with preferred stock is that issuing stock of any kind requires a formal valuation that an early-stage startup may not yet have. 

Given these issues and the relative simplicity of SAFEs, SAFEs are generally considered to be a better option for seed funding rounds. Of course, a SAFE can be structured in such a way that it converts to a certain number of shares of preferred stock when it hits a triggering event (i.e. the next financing round).

SAFE vs. convertible note

Convertible notes are short-term debt instruments oftentimes used in seed financing and venture capital. Like other debt instruments, they typically have an interest rate and a maturity date. Unlike other debt instruments, they offer the holder the ability to get repaid in equity, rather than in their initial investment of money plus interest.

One of the reasons Y Combinator launched the SAFE in the first place was to provide an alternative to convertible notes — specifically, an alternative that avoids the question of an interest rate and pares down the terms requiring negotiation for the sake of simplicity and transparency. Still, convertible notes may have some benefits over SAFEs for investors. They are certainly more customizable in terms of features such as the interest rate. They may also allow for a cash payout or some other benefit to the investor in the absence of triggering events that convert the note into equity. They may also allow the investor to collect extra equity in the form of interest.

SAFE vs. KISS (Keep It Simple Security)

The startup accelerator 500 Startups created the Keep It Simple Security (KISS) in 2014 as a response to Y Combinator’s SAFE. They are similar in many respects, but they aren’t exactly the same. 

The KISS is perhaps a bit less simple than the SAFE, but it still prioritizes ease and flexibility as far as startup founders are concerned. Investors who plan to invest across multiple rounds may also find the KISS to be an enticing option, as it is structured to provide more benefits to major investors.

Despite the simplicity of the KISS relative to many other types of equity financing, the ubiquitous SAFE remains generally more popular as an option for early-stage fundraising.  

Pre-money SAFEs vs. post-money SAFEs: What’s the difference?

We mentioned above that there are two types of SAFE: the pre-money SAFE and the post-money SAFE. We’ve written a whole guide that breaks down the differences between pre- and post-money SAFEs, but here’s a quick summary:

• In a pre-money SAFE, the conversion price for each share is determined by a pre-money valuation of the company capitalization. In other words, the valuation does not include all the shares issued to other SAFE and convertible note holders. This means that the investor does not know what percentage of the company they own until the next financing round, when their investment is converted into shares along with all the other SAFE and convertible note holders’ investments.
• In a post-money SAFE, the conversion price for each share is determined by a post-money valuation that includes all the shares issued when all the SAFEs are converted. Because investors in a post-money SAFE can get a much better idea of how much ownership of the company they’re purchasing, this type is generally viewed as a better alternative to the pre-money SAFE. Founders also stand to benefit, as a post-money SAFE helps them to better understand how their stake in the company will be affected by dilution.

Y Combinator created the post-money SAFE in 2018, largely in response to some of the vagueness associated with its initial pre-money SAFE. Given the additional transparency, it has displaced its predecessor as the preferred option for founders and investors alike.

How SAFEs balance the interests of founders and SAFE investors

Spend time in the startup community and you’ll soon learn that post-money SAFEs are the most common way to raise early-stage money. This isn’t because founders are uncreative (they are anything but!). Suffice it to say, the modern SAFE investment effectively balances the interests of founders and investors in a way that few early-stage funding options can.

Why do founders choose SAFEs?

• Less dilution of founder shares. At the close of a post-money SAFE investment, the founder instantly knows how much their own shares will be diluted. SAFEs can also result in less dilution for founders. For example, if you issue SAFEs at a $10 million cap and your next round closes at $20 million, the initial investment converts at a $10 million cap, meaning less dilution for you!
• You can defer board control to a future round. Some types of equity, such as preferred stock, may grant the holder privileges such as a seat on the company’s board of directors. Selling a SAFE doesn’t involve selling any control of your company — at least not until the next funding round.
• No complex terms to negotiate. SAFEs are so simple, it’s in the name.
• SAFEs make it easier to tailor prices to the investor. SAFEs may not require much in terms of negotiation, but they do allow founders to negotiate the valuation cap of each SAFE individually, thus favoring investors who take on more risk by coming aboard earlier. 

Why do investors choose SAFEs?

• Transparent terms and clear ownership stake. When a post-money SAFE closes, the investor already knows exactly how much ownership of the company they’ve bought.
• Saves time and money. Investors need lawyers, too! SAFEs do away with a lot of the paperwork and legalese other funding options require, and this can be a real benefit to investors who want to stay nimble when chasing the next big thing.
• Allows the startup to focus on its own growth. The more time a startup founder spends negotiating complex terms, the less time they’re spending building a product that can change the world. And that’s in nobody’s best interest — including the investor’s.
• Exposes SAFE holders to the upside of growth. Not all SAFEs convert to equity in a future funding round, but the ones that do can be a great deal for the investor who made the bet. SAFEs are among the best ways to get in on a startup’s potential early, and sometimes getting in early makes all the difference.

Solve the puzzle of early-stage fundraising with Pulley

It can be a lot to ask entrepreneurs and startup company founders to wrap their heads around all the different ways to finance an early-stage startup. And that’s to say nothing of some of the newer SAFE-related investment options out there, such as the Simple Agreement for Future Tokens (SAFT) that’s becoming increasingly popular among web3 startups.

Fortunately, SAFEs are simple by design — and powerful when used the right way. At Pulley, we believe SAFEs can be one of the strongest tools in a founder’s fundraising arsenal, and we’ve built out a ton of our own tools to help you wield them effectively:

• Pulley’s SAFE workflows let you generate and customize your SAFE terms and send for board approval within minutes.
• Pulley’s cap table management tool makes it easy to track and manage SAFEs and other types of equity on your cap table, with real-time visibility into your ownership. 
• Pulley’s fundraising modeling gives you insight into the issuance, ownership, and numbers of shares for each founder, employee, and investors in current and future equity rounds.

Interested in learning more? Schedule your demo today.