Post-Seed SAFE Series — Part 2: Five Provisions Worth Negotiating Before You Sign A Post-Seed SAFE

Picking up from Part 1: if you are investing into a company with an existing priced round, the standard Y Combinator (“YC”) SAFE leaves real money — and real rights — on the table. Here are five provisions where pushing back is not just defensible, it is expected.

1. Valuation Cap Denominator. “Company Capitalization” has three issues for post-seed SAFEs: (1) It does not specify that preferred stock should be treated on an as-converted basis, (2) It does not provide mechanisms for accounting for anti-dilution protection that may happen in connection with an applicable equity round, and (3) it generally excludes increases to the pool occurring in connection with the applicable equity round. Thought should be given to each of these items and revisions are always advisable to address both item 1 and item 2. Keep in mind that the more shares in the Company Capitalization, the lower the SAFE conversion price will be and the more shares you will eventually receive as an investor.
2. “Equity Financing” Definition. The form was built to identify the first priced round. In a post-priced-round company, it is unclear whether a subsequent Series A closing, a Series A-1 bridge, or a down-round restructuring even triggers conversion. Define Equity Financing as a new series of preferred, exclude small bridges unless you opt in, and consider making conversion optional in certain scenarios where conversion is not automatic.
3. MFN Considerations. The standard MFN captures all convertible securities. Preferred stock is technically a convertible security. This may create tension when preferred stock is issued before an “Equity Financing” happens. Accordingly, preferred stock should be excluded from the definition of “Subsequent Convertible Securities.” The optional conversion feature mentioned above can protect investors with respect to smaller issuances of preferred stock that do not trigger an “Equity Financing.”
4. Liquidation and Change-of-Control Waterfall. The YC form of SAFE does not address the priority of the SAFE relative to preferred stock that may be senior or junior to other preferred stock. This is only an issue where there are multiple classes of preferred stock. Post-seed SAFEs should typically be senior to or pari passu with the senior-most preferred stock.
5. Section 1202 Representation. Section 5(g) aggressively characterizes the SAFE as common stock for QSBS and other Code purposes. There is meaningful risk the IRS treats SAFEs as prepaid forward contracts instead. Accordingly, be sure to come to your own conclusion about tax treatment; do not inherit someone else’s tax position.

Facts and circumstances drive every deal. But “it’s the standard form” is not a reason to leave these issues unaddressed.

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.