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How does the SAFE work?
What is the SAFE?
A Simple Agreement for Future Equity
A SAFE is an investment contract between investors and companies looking to raise capital. Individuals make investments in exchange for the chance to earn a return—in the form of equity in the company—if the company experiences another round of financing, conducts a token-generation event*, is acquired or has an IPO.
The SAFE was created by Y Combinator and can be customized infinitesimally. Generally, SAFEs are financial instrument widely used by angels and VCs investing in startups.
* Recently, companies in the blockchain space have started using SAFEs as a way to sell tokenized equity, you should read these SAFE specifically for the terms and conditions associated with conversion and the risks associated with holding shares on a blockchain.
How does it work?
Investors using the SAFE get a financial stake in the company, but are not immediately holders of stock. Investments are converted to equity if certain “trigger events” occur, such as the company’s future financing, acquisition, IPO or another event pre-determined by the SAFE.
Risk note: trigger events are not guaranteed. Investors should see them only as possibilities.
How much can I earn?
Your return depends on your investment amount, the company’s exit valuation (how much the company is worth if and when the trigger event happens), and the terms of the SAFE.
Risk note: If there is never an exit valuation you may never get a return on your investment.
Terms of the SAFE
Each company can customize its SAFE, including or excluding certain provisions. Most include a valuation cap and a discount, others simply specify the price at which shares can be acquired in the future. If the SAFE includes both a valuation cap and a discount, the provision more favorable to the investor applies if there is ever a trigger event.
The below are examples of terms found in a SAFE, you may see all or some of them.
Valuation cap
The valuation cap specifies the maximum valuation at which the investment converts into equity shares or cash. This means that investors, when a trigger event occurs, receive equity shares or cash at the valuation cap price—no matter the valuation at which the company sells. Therefore, the higher the valuation of the company at the time of sale, the greater the investor’s return.
Discount
If a trigger event for the company occurs, the discount provision gives investors equity shares (or equal value in cash) at a reduced price relative to what others pay at IPO or for the company’s acquisition.
Price per share
The price per share denotes the cost per share at the time the investment converts into equity shares or cash. This means that investors, when a trigger event occurs, receive equity shares or cash as if they had purchased shares at the time of the SAFE purchase at the specified price.
When can I expect a return?
Investors can earn a return, if a trigger event occurs at a certain price threshold. Although trigger events sometimes happen earlier, many don’t occur for 4-6 years after the initial investment, and some take even longer.
Risk note: Startup investing is risky, so there’s no guarantee of a return on this kind of investment.
Can I sell my SAFE?
In general, you can only sell a SAFE after one year from purchase date and only if you find a buyer, which might not be easy to do. Some SAFEs restrict liquidity further, check the terms and conditions.
Will my SAFE get converted in the startup’s next round?
In the event of a subsequent equity financing round, the company will generally convert the SAFE. Please consult the SAFE for further details.