Simple Agreement for Future Equity
When forming a business, it is essential to enter into legally binding agreements that will protect everyone involved, a simple agreement for future equity is a great example as it acts as an equitable instrument that is widely used by entrepreneurs for the purpose of acquiring capital without issuing debt or equity.
Overview of SAFE
The simple agreement of future equity is a financing contract that mainly helps startups raise capital in their seed financing round without the complexity and cost of traditional venture capital financing.
To explain, a SAFE is an agreement between a startup and an investor, wherein the investor provides funding to the company in exchange for potential equity in the future, upon the occurrence of a specific event. The specific event is usually a future investment round, such as a Series A or Series B which is usually led by an institutional venture capital (VC) fund.
A SAFE is a simple and straightforward agreement, which reduces the paperwork and legal costs associated with other forms of fundraising. It also allows for a flexible conversion rate for the investor, depending on the future equity round.
This type of agreement allows startups to defer the valuation of their company until a later date, which can be a very attractive option for many entrepreneurs.
Understanding Simple Agreement for Future Equity
Understanding Simple Agreement for Future Equity (SAFE) is essential for startup founders and investors. A SAFE is essentially an agreement between the startup and an investor where the investor provides capital in exchange for the right to receive equity in the future.
The SAFE was introduced by the startup accelerator Y Combinator in late 2013, and it has since been used as the main instrument for early-stage fundraising by many startups. The original SAFE was determined on a pre-money valuation then Y Combinator changed its form SAFE agreement in 2018 to reflect a post-money valuation.
A SAFE also helps protect the founders in case the company fails, since the investor only receives equity in the event of a successful exit. The instrument is viewed by some as a more founder-friendly alternative to convertible notes.
In most cases, the exact amount of equity is not determined until a later date. This allows for a more flexible investment structure and does not require the startup to issue shares of stock or enter into a convertible note agreement.
In the event of conversion, the price of equity that the SAFE holders receive is lower than the price issued to VC investors of the following round. The price is based on the discount rate and valuation cap.
The Bottom Line
In conclusion, a Simple Agreement for Future Equity (SAFE) is an innovative tool for early-stage companies to raise capital without giving up equity or having to comply with cumbersome regulations. SAFE is a simple, cost-effective way to help startups quickly access the funding they need to grow and succeed.