What is a SAFE?

SAFE notes (often just referred to as SAFEs) are an increasingly popular financing instrument for early-stage investors.

If you’re investing at the early-stage, it would behoove you to understand what SAFEs are and why VCs like to use them—which is why we wrote this guide.

We’ll cover how SAFEs work, their benefits and drawbacks for founders and investors, and how they compare to other investment instruments.

What is a SAFE?

SAFE stands for “Simple Agreement for Future Equity.” Y Combinator introduced this concept in 2013 after finding that founders of pre-revenue companies were having difficulty raising their first round of funding. The standard form of SAFE was updated in 2018 as the Post-Money SAFE: our discussion here will be focused on this form of SAFE.

SAFEs are a form of convertible financing. To understand how SAFEs work, it helps to first understand what convertible notes are. Convertible notes are short-term debt instruments that convert to equity upon a predetermined event—typically a priced financing round or a liquidation event like an acquisition.

SAFEs are different from convertible notes in that they’re not a debt instrument. They’re also usually simpler and shorter. This simplicity is where much of the benefit lies for founders and investors.

What makes a SAFE “simple”?

Unlike convertible notes, SAFEs do not have:

• Maturity dates. The maturity date is the date when the note must be repaid with interest (typically 18-24 months after the initial investment). Not having a maturity date takes time pressure off founders, who no longer need to scramble to raise a priced equity round or negotiate repayment or an extension with convertible note holders.
• Interest rates. The convertible note interest rate indicates how much interest accrues before the note must be repaid or converted to equity. SAFEs remove this obligation altogether.

How do SAFEs Work?

When investors invest in a SAFE, the SAFE’s terms give them the right to convert their SAFE into equity at the company’s next equity financing round or liquidation event.

The terms of the conversion are usually determined by either a valuation cap or a discount rate:

• Valuation cap. This is the maximum price a SAFE converts at. The lower the cap, the better for investors because they’ll be able to convert notes to more shares of a company.
• Discount rate. This is the discount to the priced round valuation that SAFE holders will get when they convert. The higher the discount, the better for investors. The discount reduces the valuation used to calculate an investor’s shares, allowing them to convert into more equity.

In general, there are four types of SAFEs:

• Valuation cap only;
• Discount rate only;
• Both valuation cap and discount rate (investors get to choose which is more favorable upon conversion); and
• “Most Favored Nation” clause (no valuation cap or discount rate: SAFE holders get conversion terms based on the most favorable terms offered to investors in the next priced equity round).

What happens if a liquidation event, such as an acquisition, happens before the priced equity round?

Here, the SAFE holder generally has two options:

• Receive back the original amount you paid for the SAFE (otherwise known as a “1x liquidation preference”).
• Convert the SAFE into common stock based on the valuation cap and sell the shares as part of the acquisition. It depends on the details, but if the acquisition is for more than the valuation cap, this option is often best for investors.

How SAFEs Benefit Investors and Founders

SAFEs offer investors:

• Quicker access to early-stage investments. With only a few key terms to negotiate and a standard format, investors can use SAFEs to quickly invest in promising startups.
• Potential equity at favorable terms. Upon the company being assigned a valuation in a priced equity round, SAFE holders convert their investment into equity, usually in the form of preferred stock. Depending on the valuation cap and discount rate, the conversion terms may be significantly better than those offered to later investors.

SAFEs offer founders:

• Quicker access to financing. Compared to equity financings, SAFE roundsdon’t require lengthy negotiations, documentation, or the need to agree on a valuation.
• Increased flexibility. Because there typically aren’t shareholder voting rights or other company control provisions associated with SAFEs, founders can focus on running their company with limited investor friction.

These benefits make SAFEs an increasingly popular instrument, though they do carry potential drawbacks.

Drawbacks and Considerations When Using SAFEs

When investing via SAFEs, investors should be aware that:

• You may have to wait a long time to convert your SAFE into equity. Without a maturity date and no pressure on the company to progress toward a priced equity round, investors may find themselves waiting a long time for a conversion.
• You may not get the best deal. If you invest in a SAFE that only has a valuation cap and no discount rate, it’s possible that upon conversion you’ll get no better terms than later investors.
• You won’t earn interest. Over the short term, this may not matter much. But if a SAFE is held for a significant period of time, the costs of lost interest can add up.

Likewise, founders using SAFEs to fund their companies should be aware that:

• Your equity could be severely diluted. Many founders underestimate the level of dilution that can occur upon conversion. As a result, they may find themselves with much less control than they anticipated.
• You might put off some investors. While it’s increasingly uncommon, some investors still have preferences to invest in convertible notes or priced equity rounds.
• Delaying hard questions can lead to trouble. Delaying the “valuation question” is a double-edged sword. While it offers speed and flexibility, it also risks causing problems further down the line. For example, founders may offer a valuation cap that is low to close a SAFE investment quickly without considering its actual impact upon conversion.

Estimating Ownership Dilution From SAFEs

The dilution possible when issuing SAFEs is a major factor that founders and investors should understand. A simple back-of-the-envelope way to gauge the levels of dilution is by using the following formula:

For example, if you raise $500k from a SAFE with a $5M post-money valuation cap, you are effectively selling 10% of your company. If you raise $1M with the same post-money valuation cap, that number rises to 20%.

The lesson for founders: Pay close attention to how much future equity you’re giving up when raising money with SAFEs.

SAFEs vs. Convertible Notes: How to Choose

SAFEs were introduced as a direct alternative to convertible notes. While there’s no “one size fits all” answer to which investment instrument is best, here are questions to help you decide which approach makes the most sense for you:

For founders:

• How quickly do you need to raise capital?
• Who are your investors likely to be? If they’re experienced early-stage startup investors, they’ll likely be comfortable investing via a SAFE.
• How much money do you plan to raise? Typically, lead investors investing more than a few million dollars want to invest via an equity financing round.

For investors:

• Are you willing to take on the uncertainty of potentially waiting a long time for a conversion event?
• Are you willing to forgo the added economic benefit of interest payments?
• Do you think the valuation cap and/or discount rate offered in a SAFE is worth the additional uncertainty around pricing?

Not All SAFEs Are Created Equal

Although SAFEs were designed to be standardized, some companies will use SAFEs that don’t follow the standard form.

The standard form of a Y-Combinator Post-Money SAFE includes the following message at the top:

“This SAFE is one of the forms available at http://ycombinator.com/documents and the Company and the Investor agree that neither one has modified the form, except to fill in blanks and bracketed terms.”

If the SAFE you’re using does not include this language, it’s worth an extra careful review to understand how it differs from the standard form.

SAFEs on AngelList

SAFEs are used extensively on AngelList in early-stage deals. They can be a valuable instrument for investing in startups—provided both parties understand what they are agreeing to.

Need to spin up your own SAFE documents? SAFE.new by AngelList allows founders to generate a pre-money or post-money SAFE in a few clicks of a button. Try it out ->