United States: Selecting An Appropriate SAFE For Your Financing

Assuming that a startup company and an investor are comfortable with the recently formulated Simple Agreement for Future Equity ("SAFE") as the investment vehicle to finance the startup company's early operations, the parties are then faced with the question of which version of SAFE is appropriate for the investment. Fortunately, the possible list of answers should be familiar and revolve around concepts identical to those used in convertible note financings: valuation caps, discounts, most-favored nation provisions, and combinations thereof.

SAFE with a Valuation Cap

The "standard" SAFE contains solely a valuation cap, with no discount rate applied to the investment. This means that at the time of the next applicable round of equity financing, the investors will be entitled only to the number of shares of preferred stock calculated with the valuation limitation and not a higher pre-money valuation. However, it is important to note that because the preferred stock the investor receives in the applicable equity financing will contain a liquidation preference that equals only the amount invested in the SAFE (as opposed to a liquidation preference equal to the price of the shares preferred stock issued to the new investors), the investor will receive a separate series of preferred stock than the new investors, with the only difference being a per share price attributable to the preferred stock. Below is an example provided by Y Combinator of how the "Valuation Cap Only" SAFE will practically be converted in an equity financing:

Valuation Cap Only SAFE Example

  • The investor has purchased a SAFE for $100,000. The valuation cap is $5,000,000.
  • The company negotiates with new investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company's fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000 shares.

The company will issue and sell 1,100,000 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue and sell 220,000 shares of Series A-1 Preferred to the SAFE investor at $0.4545 per share.

In the SAFE, the Series A Preferred is referred to as "Standard Preferred Stock" and the Series A-1 Preferred is referred to as "SAFE Preferred Stock." The table below sets forth a comparison between the Standard Preferred Stock and the SAFE Preferred Stock, as each would be described in the company's certificate of incorporation:

Standard Preferred Stock SAFE Preferred Stock
Liquidation preference on a per share basis: $0.909 $0.4545
Aggregate payout in a change of control transaction (each series pari passu with the other): $1,000,000 $100,000
Conversion price and original issuance price at the time of the Series A Preferred financing: $0.909

(initially converts into 1,100,000 shares of common stock)
$0.4545

(initially converts into 220,000 shares of common stock)

SAFE with a Discount

A different version of the SAFE includes only a discount, which will be applied to the price per share a Standard Preferred Stock sold in the equity financing, which will be equally applied to the conversion of the SAFE into shares of SAFE Preferred Stock. Below is an example provided by Y Combinator of how the "Discount Only" SAFE will practically be converted in an equity financing:

Discount Only SAFE

  • The investor has purchased a SAFE for $20,000. The discount rate is 80%.
  • The company has negotiated with new investors to sell $400,000 worth of Series AA Preferred Stock at a $2,000,000 pre-money valuation. The company's fully-diluted outstanding capital stock immediately prior to the financing is 10,500,000 shares.

The company will issue and sell 2,100,000 shares of Series AA Preferred at $0.19047 per share to the new investors. The 20% discount applied to the per share price of the Series AA Preferred is $0.15237. Accordingly, the company will issue 131,259 shares of Series AA-1 Preferred to the SAFE holder at $0.15237 per share.

SAFE with a Valuation Cap and a Discount

A SAFE may also contain both a valuation cap and a discount, but only either the valuation cap or the discount rate will apply when converting the SAFE into shares of SAFE Preferred Stock, not both. In this scenario, like with a Discount Only SAFE, the discount rate will be applied to the per share price of the Standard Preferred Stock in the applicable equity financing; and if this calculation results in a greater number of shares of SAFE Preferred Stock for the investor, the per share price imposed by the valuation cap. Below is an example provided by Y Combinator of how the "Valuation Cap & Discount SAFE" will practically be converted in an equity financing:

Valuation Cap & Discount SAFE

  • The investor has purchased a SAFE for $100,000. The valuation cap is $8,000,000 and the discount rate is 85%.
  • The company has negotiated with new investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company's fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000 shares.

The company will issue and sell 1,100,000 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue Series A-1 Preferred to the investor, based on the valuation cap or the discount rate, whichever results in a lower price per share. The 15% discount applied to the per share price of the Series A Preferred is $0.77272. The valuation cap results in a price per share of $0.72727. Accordingly, the company will issue 137,500 shares of Series A-1 Preferred to the investor at $0.72727 per share. The discount rate will not apply.

SAFE with a Most Favored Nation Provision

Regardless of whether a SAFE contains neither, either or both a Valuation Cap or a Discount feature, a SAFE may contain a "Most Favored Nation" provision ("MFN Provision"). The MFN Provision allows the holder of that SAFE to amend the terms of the SAFE to include terms in a latter-issued SAFE that the holder of the SAFE identifies as being more advantageous than the terms of the SAFE with the MFN Provision. For example, if an investor holds a SAFE with an MFN Provision and a Valuation Cap of $10,000,000, and subsequent to the issuance of that SAFE, the company issues to a new investor a SAFE with an $8,000,000 Valuation Cap, the first investor will have the opportunity to amend the terms of the SAFE with the MFN Provision and $10,000,000 Valuation Cap to include the $8,000,000 Valuation Cap. It is important to note, however, that if the subsequently-issued SAFE does not also contain an MFN Provision, the MFN Provision will essentially be "amended away" by exercising the MFN Provision in the original SAFE.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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