In 2013, Y Combinator took the “convertible security” circulating among influential Silicon Valley lawyers, simplified and rebranded it as a Simple Agreement for Future Equity (SAFE), and used its market power as arguably the most prestigious startup accelerator in Silicon Valley to spread the SAFE across the startup fundraising world.
Why use a SAFE?
Startups prefer to fundraise using SAFEs because they require minimal negotiation and can be closed quickly. In some cases, companies and their investors can complete entire SAFE financings in as short as a few days. However, despite the relative speed and simplicity of raising money with SAFEs, startup founders still have critical decisions to make and best practices to follow whenever they raise money.
Choosing a Form of SAFE
The first decision a startup should make when fundraising with SAFEs is whether to use the Pre-Money SAFE or the Post-Money SAFE. Each has its advantages and disadvantages.
The Post-Money SAFE
If you’re raising money from Y Combinator (YC), you will be using a Post-Money SAFE, which YC introduced in 2018. The Post-Money SAFE has the advantage of being super-streamlined. In this iteration of the SAFE, YC stripped away annoying elements of the standard Pre-Money SAFE, such as the promise of future pro rata rights to all investors. The Post-Money SAFE is pretty much non-negotiable, except for a couple of key terms like the valuation cap and discount.
The disadvantage of the Post-Money SAFE is that it is protective of investors to the detriment of a startup’s founders. As a founder, if you’re confident that your Post-Money SAFE round is the only round of financing that your company will raise before its institutional equity round, then the Post-Money SAFE may be the appropriate fundraising instrument to use. Otherwise, if the startup needs to raise additional money before the Post-Money SAFEs convert, then using the Post-Money SAFE would expose the founders to unwanted further dilution while protecting the Post-Money SAFE investors from such dilution.
The Pre-Money SAFE
The Pre-Money SAFE was the original version of the SAFE introduced by YC in 2013. The standard Pre-Money SAFE documents contained gotchas for companies who downloaded them off the YC website and used them off-the-rack, without modifications. As noted above, one main gotcha was the promise of future pro rata rights to all investors, regardless of the amount they invested. Over time, startup lawyers created for their clients lightly modified standard forms of the Pre-Money SAFE that are less annoying to use. The Pre-Money SAFE is still widely used today. It has the advantage of being familiar to companies and investors, easy to use with limited negotiation, and marginally better than the Post-Money SAFE for founders and how startups tend to raise money (i.e., when and as needed).
If a startup has the choice, I generally recommend raising money on a lightly modified Pre-Money SAFE. If you’re deciding between the forms of SAFE, discuss your fundraising plans with your startup lawyer to fully understand the differences and the potential impact of their use on your company’s capitalization.
The SAFE Fundraising Process
Once you’ve decided to fundraise using the SAFE, here is what you might expect and some general steps to ensure that the process goes smoothly for you:
Discuss the Terms of the SAFE Financing Round with Your Lawyers
Discuss the terms of the SAFE financing round with your lawyers. Important issues in a SAFE financing round include:
- whether you want to use the Pre-Money SAFE or Post-Money SAFE,
- any discount or valuation cap,
- the amount of money the company wishes to raise (which impacts dilution of existing stockholders),
- any additional rights the company is willing to offer to its investors, such as pro rata rights or most-favored nation (MFN) rights, and
- any investment amount thresholds that investors should meet to obtain those rights.
Have Your Lawyers Prepare the Fundraising Documents
Have your lawyers prepare the fundraising documents, especially if you are using a Pre-Money SAFE. Even when using SAFEs, your company needs to document any corporate approvals required for the SAFE financing. These include the board of directors’ approval, sometimes the consent of the company’s stockholders, and any other consents or waivers that may be necessary under existing agreements. Your lawyers can also advise on any specially negotiated side agreements with your investors. There can be some lead time as the company finalizes these documents.
Prepare for Due Diligence
You can expect any financing to involve some due diligence on the part of your investors. Even in an early-stage SAFE financing, larger investors or their lawyers may ask to see your company’s formation documents and proof that all intellectual property relevant to your business has been assigned to the company.
Prepare for Securities Law Compliance
Compile a list of investors, their investment amounts, and the addresses of their residence or principal place of business. Your lawyers will use this information to determine what your company needs to do to comply with federal and state securities laws.
Closing the SAFE Financing
When documents are final, the company may begin closing the SAFE financing. Closing means the process of the investors sending their money to the company, and in exchange, the company issuing SAFEs to the investors.
Sometimes, once a template SAFE has been prepared with the lawyers’ help, companies choose to handle closing by themselves. They will fill in the investor’s name and investment amount on the SAFE, obtain the company’s and the investor’s signature, and deliver the SAFE to the investor when they receive the investor’s money. This can be a cost-effective approach if done correctly. In my experience, some companies are better at keeping good records than others.
Other companies prefer their lawyers to coordinate obtaining all signatures from the company and the investors, sending the company’s wire instructions to investors, and tracking incoming signatures and money. In these cases, as signatures and funds arrive in the company’s account, the lawyers will finalize the SAFEs and any other fundraising documentation and distribute compiled final transaction documents to the relevant parties.
After the SAFE Financing Is Closed
After the SAFE financing is closed, the company’s lawyers can update the company’s capitalization records, make any required securities filings with federal and state governments, and track and help the company comply with any new investors’ rights. With the financing round closed, the company can refocus on hitting its next growth milestones!