We used a SAFE to raise $1.2M in seed funding, and it was very efficient

Disclaimer: this is not lawyer advice. We used a SAFE to raise our seed funding and found it very efficient, so I wanted to share what we learned here. If you are unsure, always ask a (real) lawyer!

Incorporating a company is generally a null-brainer process. It takes a few hours and a few hundred bucks in most countries to get the cookie-cutter Ltd or Plc up and running and get your business started.

Raising equity with external investors can rapidly become a much more complex matter, expensive and time-consuming. Precisely what you don't want as a startup;

• Most of the time, you are dealing with securities law. Who can invest and how many of them can be tricky questions.
• All investors have to agree on the same terms, making negotiations more complex and time-consuming.
• You need to agree on a company valuation, which is not easy at a very early stage.
• You will need a shareholder agreement and probably a board of directors outside your initial founders' circle.
• The signing and closing process is painful: all investors will have to sign at the same time.

Y-Combinator came up with a pretty neat solution called "Simple Agreement for Future Equity" or SAFE, which solves most of the problems above.

Why is a SAFE more straightforward than a straight raise?

As the name has it, a SAFE - Simple Agreement for Future Equity - is an agreement between the company and ONE investor. If that investor wants to invest 100,000$ in your company, they wire you the money, and upon certain FUTURE conditions, the investor will receive EQUITY in the company. In the meantime, what the investor holds is DEBT.

And this does simplify a lot of things:

• Y-Combinator's SAFE comes as an industry template. This is a powerful negotiation tool: you do not want to deviate from the template as it is widely recognized.
• In most countries, private debt falls under less strict regulation than equity. (This will have to be confirmed by a local lawyer.)
• Each investor will sign their own document, which means that you can negotiate different terms with each investor. But also, once one investor has signed, they can send the funds, and you can get going immediately.
• You can always issue more SAFEs in the future, making it a very flexible bridge funding tool.
• The conversion into equity is in the future: most likely at a moment where you are raising a Series A, and where you can afford more time and money with lawyers and VC investors.
• The valuation discussion is much easier, as we can see below.

How does a SAFE work in practice?

The most basic SAFE is the post-money SAFE with a valuation cap. Assume an investor wants to invest 100,000$ into your company and that they agree your company is today worth 2m$ post-money. (For beginners, 2m$ "post-money" means that the 2m$ includes the 100,000$ your investor is giving you. In other words, the "pre-money" valuation is 1.9m$.)

What the SAFE contract says is:

• You give me 100,000$ today.
• When (in the future) I do a real equity raise (e.g., Series A), your 100,000$ will convert into a % of shares in the company.
• If the company's valuation for the Series A is above 2m$, the 100,000$ will convert into 5% of equity (pre-money of the Series A). The 5% comes from 100,000$ / 2m$.
• If the company's valuation for the Series A is below 2m$, for example 1m$, the 100,000$ will convert into 100,000$ / 1m$ = 10%.

As you can see, if the valuation of your company for the Series A is lower than the agreed cap (2m$), then you are diluted as the investor is getting more shares than you initially expected. If the valuation is higher, you are giving up precisely the expected 5%.

This is a compelling argument for the investor. You agreed on a 2m$ cap:

• If the Series A valuation is below, the investor is not losing money as they receive shares worth their initial 100,000$. The extra shares they are receiving are shares you are not keeping as a founder.
• If the Series A valuation is above, the investor makes money (on paper). For example, if the series A valuation is 5m$, they receive 5% of 5m$ or 250,000$ worth of shares. That is a 2.5x multiple.

Negotiating the cap is the essential part of the SAFE: too high a cap and you could get diluted a lot. To low a cap, and you are giving up a lot of equity up-front.

A highly flexible tool

Because each SAFE is a standalone agreement between your company and ONE investor, it will make your life much easier:

• You can negotiate separate terms with each investor: one can have a cap at 1.5m$, the other one at 3m$, a third one at 5m$.
  You don't have to do one big complex closing: each investor signs their own SAFE, wires you the money, and you can move on.
• Each SAFE will exist independently, and investors can remain anonymous.
  Some investors might, however, ask always to have the best terms offered to others. This "Most Favoured Nation" is a clause or letter by which you agree that if you give better terms to another investor, they will benefit from the same terms.

As a conclusion

SAFE are generally much simpler and faster to operate than a straight equity raise. It will save you a lot of time and lawyer money and operate under an industry-standard supported by Y Combinator.

The flip side is that the SAFE doesn't freeze your company valuation for this round, and you are exposed to dilution risk if your net raise falls below the cap you had set.