SAFE Investment Instrument for Beginners - All You Need To Know
A SAFE stands for a “simple agreement for future equity”. The mechanism was authored by Y Combinator lawyer Carolynn Levy and open sourced. It was created and published as a simple replacement for convertible loan notes (CLNs).
A SAFE is an agreement between an investor and a company that provides rights to the investor for future equity in the company similar to a warrant, except without determining a specific price per share (or a valuation) at the time of the initial investment.
This element (no valuation) is key especially in start-ups in certain sectors where the future earnings of the company are very difficult to quantify.
In practice a SAFE enables a start-up company and an investor to accomplish the same general goal as a convertible loan note, though a SAFE is not a debt instrument.
The SAFE investor receives the future shares (typically at a discounted price) when a priced round of investment or liquidity event occurs. SAFEs are intended to provide a simpler mechanism for start-ups to seek initial funding than convertible notes.
SAFEs solve a number of issues that convertible loan notes have for start-up companies. Because SAFEs are not debt instruments, they remove the threat of insolvency that a convertible loan note can cause, and they remove the need for founders to go back to investors to request maturity date extensions (this also saves investors from having to deal with extension paperwork). Additionally, SAFEs reduce the amount of legal cost and negotiation time by simplifying the agreement relative to most convertible loan notes.
Unlike a convertible loan note, a SAFE is not a loan; it is more like a warrant. In particular, there is no interest paid and no maturity date, and therefore SAFEs are not subject to the regulations that debt may be in many jurisdictions.
While the SAFE may not be suitable for all financing situations, the terms are intended to be balanced, taking into account both the start-up’s and the investors’ interests. There is a trade-off between simplicity and comprehensiveness, so while not every edge case is addressed, it is believed the SAFE covers the most pertinent and common issues.