SAFE Agreements for Startup Capital Raising
Simple Agreement for Future Equity (SAFE)
SAFE (Simple Agreement for Future Equity) investment agreements have become an increasingly popular fundraising tool in recent years. These agreements facilitate early-stage investment between investors and entrepreneurs during the initial phases of a startup’s development. Below, we explain what a SAFE agreement is, how it works, and its key advantages and disadvantages for both founders and investors.
By Igal Mor, Adv. & Notary
Accuracy in Legal Advice. Excellence in legal support.
What Is a SAFE Agreement?
To understand the SAFE agreement, it helps to first understand how startup investment typically works. In its earliest stages, a startup company generally lacks a clear market valuation, making it difficult to determine a fair price per share. Traditional fundraising rounds require establishing this valuation — a process that can be time-consuming, costly, and contentious. The SAFE agreement was developed as a streamlined alternative that allows investment to proceed without requiring an immediate company valuation.
SAFE agreements are typically executed during the earliest stages of a company’s capital-raising efforts. Under the agreement, the investor provides funding in exchange for the right to receive equity in a future financing round, rather than receiving shares immediately. The conversion to equity occurs when a qualifying event takes place — usually the company’s next priced funding round.
When Is a SAFE Agreement Used?
A SAFE agreement is an effective solution when a company has an immediate need for capital but does not wish to conduct a full fundraising round involving the issuance of shares. SAFE agreements are particularly useful when a startup needs to raise capital quickly between formal financing rounds, allowing founders to secure funding without the delay and expense of a traditional equity offering.
Key Benefits of SAFE Agreements
The primary advantage of a SAFE agreement is that it enables both parties to formalize an investment arrangement even when they disagree about the company’s current valuation — without the need for lengthy and costly negotiations. For entrepreneurs and startup founders, SAFE agreements provide a valuable mechanism for raising capital during the earliest stages of development, before a clear valuation has been established.
For investors, the SAFE agreement secures the right to acquire equity at a later date once the company’s value becomes clear. Additionally, SAFE agreements typically include provisions for purchasing shares at a discount or subject to a valuation cap, giving the investor preferential terms compared to participants in later funding rounds.
Types and Structures of SAFE Agreements
Drafting SAFE agreements requires considerable skill and precision. These agreements include various conditions governing the investor’s right to purchase shares in the future. A SAFE agreement may provide for a future share purchase at a discount (for example, 10% or 20% below the price paid by new investors). It may also include a valuation cap — a maximum price per share that the investor will pay regardless of how high the company’s valuation rises in the next funding round. The valuation cap protects the investor in the event that the company’s value increases significantly between the SAFE investment and the next priced round.
SAFE agreements are generally structured according to one of four types: a SAFE with both a discount and a valuation cap; a SAFE with a discount only; a SAFE with a valuation cap only; or a SAFE MFN (Most Favored Nation) agreement — which includes neither a valuation cap nor a discount but grants the investor the right to purchase shares in the future on the most favorable terms offered to any subsequent SAFE investor.
Key Risks to Watch For
As with any investment agreement, it is essential to review the terms of a SAFE agreement carefully and in detail to avoid unfavorable outcomes. SAFE agreements can carry significant disadvantages for entrepreneurs who need immediate funding, as they may grant disproportionate privileges to investors at the founders’ expense. Conversely, a poorly structured SAFE agreement can also harm investors’ interests. For example, a SAFE that includes neither a valuation cap nor a discount may leave the investor at a disadvantage relative to participants in the next funding round.
Essential Considerations for Entrepreneurs and Investors
Whether you are an entrepreneur or an investor, there are several critical points to keep in mind when negotiating a SAFE agreement.
One of the investor’s primary concerns is that no subsequent funding round will occur, leaving them unable to exercise their equity conversion rights. To address this risk, it is strongly recommended to include a provision allowing the investor to purchase shares at a predetermined price if the company fails to raise additional capital within a specified period. From the investor’s perspective, it is also advisable to negotiate terms that include both a discount rate and a valuation cap to maximize downside protection.
A third option that may benefit both parties is to include pro-rata rights in the agreement. By exercising these rights, the investor can maintain their percentage of ownership in subsequent fundraising rounds. This is an important consideration because each new round of capital raising involves the issuance of additional shares, which dilutes the ownership stake of existing investors. Offering pro-rata rights attracts committed investors who intend to support the company over the long term.
At Adv. Mor & Co., our commercial law department has extensive experience advising startups, investors, and established businesses on SAFE agreements, corporate structuring, and all aspects of business-related legal matters.
Contact us by phone at 02-595-3322 or by WhatsApp at 050-443-1343 for expert legal advice on SAFE agreements and startup investment.