“SAFE” Fast and Effective Funding for Your Start-up
Acquiring funds can at times be difficult and, in many cases, start-up founders have to agree to lengthy and unfavorable terms in order to acquire funding for their business. Rather than using conventional funding models such as costly and complicated convertible notes, Aviv Lazar & Co. can help you draft a “SAFE”.
What exactly is a SAFE and how does it work?
A SAFE is a “Simple Agreement for Future Equity,” which is a contract used by start-ups in order to raise capital in the early stages of fundraising. These investment agreements are signed between a start-up and an investor. Upon signing the agreement, the investor agrees to provide the company with a certain amount of money, and in return, the investor is granted the right to receive equity of the company in the future, based on the amount invested.
Three Reasons Why SAFEs are Beneficial to Start-up Founders
SAFEs are an approachable alternative to convertible notes and offer several benefits to the founders of start-ups:
First, SAFEs are more simple than convertible notes because they are inherently shorter, reaching about five pages, and they do not contain an end date.
Second, because SAFEs are relatively straightforward and short, they often require less negotiation time than convertible notes. The reduced negotiation time associated with SAFEs save start-up founders money which would normally be spent on transactional and legal costs.
Third, SAFEs are financially advantageous to start-up founders because they do not require interest to be paid on the loan from the investor. Thus, start-ups engaged with an investor in a SAFE are only responsible for repaying the initial loan.
2 Reasons Why SAFEs are Beneficial for Start-up Investors
While providing funds to a young and unknown company may seem risky, investing using a SAFE can be beneficial to investors. SAFE agreements allow an investor to continue to be involved with the company, past his initial loan, as he will have the right to purchase shares upon the occurrence of an agreed upon future event.
First, a significant majority of SAFEs include either a valuation cap, a discount or both. A valuation cap sets the highest price that can be used to convert an investment into shares. A discount is when a lower price is given for shares than the stock’s value. Both options are beneficial for investors because they allow them to gain shares at a lower price than would normally be available. This benefit is seen as compensation for the investor for taking the risk of investing early.
Second, SAFEs include Pro-rata rights. Pro rata rights are intended to allow the investor to continue to maintain the market share that they had before subsequent funding rounds. This is done by guaranteeing them the opportunity to participate in future fundraising rounds and giving them the option to purchase additional shares in order to maintain their percentage ownership of the company. Generally, these rights are only given to investors who contribute a significant amount of money to the early stage funding of a start-up.