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.

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