Playing it "SAFE" with Pre-Seed Financing

Matthew McElwee

October 17, 2022

VC & Startup

What is a "SAFE"?

For many startups, there is a period of market and product validation that requires capital before they’re ready for an equity financing. There are a number of options available to founders at this stage – loans, self-financing, convertible notes, credit cards (not recommended). For those founders seeking pre-seed investment to fund this period of validation, a “SAFE” – or, Simple Agreement for Future Equity” – can be an ideal mechanic.

Unlike debt (whether a line of credit or a convertible note), a SAFE has no maturity date and no accruing interest.

Unlike debt (whether a line of credit or a convertible note), a SAFE has no maturity date and no accruing interest. As a result, a SAFE can be useful for the earliest investments when the timing of a future priced round is unknown. As “Simple” as they are intended to be, however, SAFEs come with their own mechanics and complications.

The SAFE itself is issued by the company in exchange for the investment amount, with one or both of a Valuation Cap and a Discount. When both mechanics are included in the SAFE, the investor typically gets the better result of either mechanic. Each mechanic determines how the investment amount will convert into equity at the company’s next priced round of equity. A Valuation Cap sets the maximum company valuation at which the SAFE will convert (regardless of the valuation applied to the priced round); a Discount applies a percentage reduction to the subsequent equity round’s price per share.

When to use a SAFE

SAFEs are not without downsides, and they certainly don’t fit every situation. Unchecked, multiple rounds of SAFEs at different valuation caps or discounts can result in a complex priced round cap table, cause significant and unintended dilution for founders and even deter VC’s once the diligence phase of a priced round begins. Using SAFEs responsibly requires careful planning and founder discipline.

If you are a founder or startup looking to raise capital with SAFEs or explore other options, reach out for guidance before you start – we’re happy to help.

More Insights & Articles

VC & Startup
May 16, 2024

Data Rooms and Due Diligence: Raising Capital from Investors

The data room is one of the most important aspects of the due diligence process of any fundraising round.
VC & Startup
April 26, 2024

Unshackling Talent: FTC issues Nationwide Ban on Non-Compete Contracts

In a historic move on April 23, 2024, the U.S. Federal Trade Commission (FTC) issued a ruling banning non-compete clauses in the vast majority of employer-employee contracts.
VC & Startup
April 15, 2024

The Big FAQs About TOU

TOU are a set of rules and guidelines that govern the use of a website, app, or online platform
VC & Startup
March 27, 2024

Operating Agreements for LLCs

The operating agreement directs the internal mechanics of the business and aligns the goals of its members by contractually binding them to its terms.
VC & Startup
March 13, 2024

The Art of Startup Resilience: Surviving and Thriving in a Bear Market

Ten ways that startup founders can stand out and get access to capital in a bear market.
VC & Startup
March 4, 2024

Understanding Equity Rounds: A Primer on Pre-Seed vs. Seed vs. Series A

In order to secure the proper funding, founders must first understand how the different financing rounds typically work.
VC & Startup
February 8, 2024

83(b) Elections: Advantages & Disadvantages

Individuals who own equity in a startup face uniquely complicated tax issues that require efficient strategies to minimize immediate and future tax liability.
VC & Startup
January 31, 2024

Seller Financing in Sale Transactions

While it involves more risk, seller financing can be very beneficial for all parties involved.
VC & Startup
January 29, 2024

Delaware C-Corporations: The First Choice for Founders and Investors

For startups looking to sustainably grow using equity funding, founders should seriously consider the default of a Delaware C-Corporation.
VC & Startup
October 31, 2022

What is a Certificate of Incorporation?

A Certificate of Incorporation (also known as a charter) is a document that establishes the legal existence of a corporation.
VC & Startup
October 17, 2022

Term Sheets - A Crucial Brick in a Solid Foundation

When used correctly, term sheets can shorten deal cycles, prepare the company for future rounds, and limit legal spend on both sides of the deal.