There are many ways to raise funds from investors. When raising money, you need to decide on what to sell to investors, and for how much. Most people think of investing as an investor giving you money in exchange for equity, shares or stock in the company. Although this is a common and simple way to structure an investment, it is not the only way.

For early stage fundraising like a seed round, businesses often use a different method - a convertible instrument. With a convertible instrument, investors give the business money now, and in return, the business promises to set shares aside for those investors when certain terms are met. Terms will vary deal to deal, and typically coincide with another round of raising money.

Convertible instruments may be preferred for early stage fundraising because they delay the need to determine a valuation up-front, saving time and money. This can be beneficial  for fundraising at the early stages of a company. These types of investments are viewed as higher risk, and therefore often have higher rewards than other types of investments.

There are two types of convertible instruments - Convertible notes, and SAFEs. In this blog post, we will focus on SAFEs.

For a more in-depth primer on convertible instruments with examples, see the video below.

What is a SAFE?

A SAFE (Simple Agreement for Future Equity) is when investors give money to the business, and in return the business promises to convert that money into shares later on if a triggering event occurs. For a SAFE, the investment typically converts into shares when the business raises a round of money that puts a valuation on the business.

Key terms to understand for a SAFE

  • Share price: How much money a single share of a company is worth.
  • Priced Round: A round of financing where each share of the company has a set price. This gives the company a valuation.
  • Valuation: How much money a company is worth, in total. This is the sum of all share values.
  • Conversion: SAFEs convert into shares of stock when a “triggering event” occurs. The triggering event is usually the company’s first priced financing round. When this happens the SAFEs convert into equity (shares, stock, LLC interests, etc.) of the issuer after taking into account any early-stage incentives, such as valuation caps or discounts, relative to the price paid by the new (priced round) investors.
  • Early-stage Incentives:
  • Valuation Cap: The predetermined value that a company uses to calculate SAFE investment share prices when the SAFE investments convert into shares.
  • Discount Rate: A discount, per share, for SAFE investors that gets applied to the SAFE investments when they convert.
  • MFN (Most Favored Nation) Clause: If future SAFE investors receive better terms (e.g. lower valuation caps or larger discounts), then the initial SAFE holders have the option to receive those same terms.

Example SAFE Investment Scenario

  1. Today, Mike invests $1,000 in your company using a SAFE note that has a $1 Million valuation cap. Mike is investing with the expectation that your company will be worth more than $1 Million by the time you raise money that gives your company a valuation. At the time of this investment, your company does not have a valuation. Nobody knows what shares are worth or what the company is worth, however, depending on the type of SAFE, everyone may know how percentages will be split upon conversion.
  2. One year later, you raise money again. As a result of the investment of a new investor, Sydney, your company is valued at $2 Million (valuation). Sydney invests $1,000 in your company in exchange for 1,000 shares. This means that each share of your company is now worth $1 (share price), and you have a total of 2 million shares.
  3. Mike’s initial SAFE investment converts because this new round of investment meets the SAFE’s requirements for existing SAFE holders, like Mike, to convert into shares of stock. With the valuation cap of the SAFE at $1 Million, your business issues shares to Mike as if the company is worth $1 Million and makes a corresponding entry on your capitalization table.
  4. To calculate Mike’s share price from the early SAFE investment, you take the valuation cap of $1 Million and divide it by the new valuation of $2 Million. This results in $0.50 being Mike’s share price.
  5. Mike’s $1,000 SAFE investment converts into a total of 2,000 shares because he bought each share for $0.50.
  6. Mike now owns 2,000 shares for his initial $1,000 SAFE investment. Sydney now owns 1,000 shares for her $1,000 investment.

For a great explanation and example of how SAFE investments work, see video below.

When does it make sense to use SAFEs to raise money?

SAFEs create a streamlined way to raise capital at an early stage because it is hard to give early stage companies a valuation. So these convertible instruments are typically used for early stage companies that need money for rapid growth, but are too early to provide a comfortable valuation. Unlike convertible notes, Issuers do not need to pay interest accruing during the time until the SAFE converts to equity. Due to how SAFEs work, they are sometimes considered a higher risk higher reward opportunity for investors. If the following aspects are important to you for your funding round, then you should consider using a SAFE. For issuers, SAFEs provide:

  • Less negotiation
  • Fast process
  • Delay company valuation

Please note that this blog post discusses SAFEs in general, and the terms of any specific SAFE could and likely will be different than what is shown in the examples above. Like any other type of investment SAFEs come with serious risks, including the risk that you could lose all of your money. To better understand the risks of investing in a SAFE we recommend you read FINRA’s article on 5 Things to know about SAFEs and Crowdfunding.

With so many ways to raise money, structuring an offering can be intimidating. We do our best at Common Owner to make it as easy as possible, so we can provide SAFE templates upon request for your crowdfund offerings. Please reach out with any questions!

Email us anytime at [email protected].

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