What is a SAFE?
The Simple Agreement for Future Equity (SAFE) is a “friends and family” investment tool: an early equity-financing instrument that has become increasingly popular with early-stage startups since its introduction in 2013. SAFEs were designed to simplify and replace convertible notes, so a SAFE allows a startup to take in money on a rolling basis from multiple angel and pre-angel investors in exchange for a promise of equity later down the line. Because SAFEs don’t require a valuation or for an entire round to close all at once, they make it much easier to work with casual investors, especially personal acquaintances who do not typically make a habit of investing in startups.
Essentially, a SAFE is a promise that the money the investors put in today will translate into an equity stake with preferential pricing terms when the startup eventually issues preferred stock. Unlike a convertible note, a SAFE is not a debt instrument, so there’s no expectation that the investment will be repaid if it never converts to equity.
SAFEs typically come in four varieties: with or without valuation cap, and with or without a discount. Both of these variables relate to the startup’s first priced round, which usually means issuing preferred stock to professional investors at a specific valuation that determines the price-per-share of the startup’s equity.
A valuation cap refers to the maximum valuation allowed in this round—if the SAFE contains a valuation cap, any increase in the valuation above that cap will not affect the price of the equity that the SAFE’s investors receive. In other words, if a SAFE contains a valuation cap of $1M, but the startup closes its first round at a $2M valuation, the SAFE investors will receive an equity stake proportional to the $1M valuation instead.
The discount describes the amount by which the cost of the equity will decrease for the SAFE’s investors. If a SAFE specifies a 20% discount (which is typical), the money each investor puts in will translate to 125% of the shares their stake could buy at the price-per-share in the round—if a SAFE investor puts in $100 and the next round specifies a $1 price-per-share, their stake would buy 125 shares at the discounted $0.80 price-per-share rather than 100.
Both of these mechanisms create the potential for high dilution at the next round, especially when the startup issues multiple SAFEs and convertible notes, so SAFEs have begun to develop a reputation for being dangerous to founders. Fortunately, there are methods to reduce this risk, and Gust has built these methods into the SAFEs available to founders through Gust Launch.