As a startup and venture lawyer, it is common for a startup founder in Malaysia to ask me whether it is legal to issue a Simple Agreement for Future Equity (SAFE) round for his Malaysian company.
The answer is yes. You can raise funds using a SAFE round in Malaysia. But the usual standard template SAFE that you can get on Y Combinator’s website may not be suitable for the Malaysian format.
Coming back to Y Combinator’s SAFE earlier, unfortunately, the SAFE agreement needs a lot of customisations and localisations as it was prepared based on United States laws (usually a startup is formed in the state of Delaware). Therefore a local startup lawyer will need to review it to ensure that the SAFE agreement can work under the local laws.
Why is a SAFE document so important in a startup financing ecosystem?
SAFE may be considered as one of the most important and innovative legal instruments that was developed by Silicon Valley venture lawyers.
SAFE has helped founders save money on expensive legal fees and avoid the legal and administrative hassles usually involved in a priced round (i.e. an equity based investment round in which there is a defined pre-money valuation) especially in the pre-seed and seed stage.
So a SAFE agreement has a lot of benefits and is usually preferred by early stage seed investors when it’s hard to value a new 3 or 6 months old company when valuation will be hard, speculative or a futile exercise.
So don’t be surprised if you would come across different types and variations of SAFE agreements (depending on where your startup may be based).
In other words, a SAFE agreement prepared for a Singaporean startup will need to be customised by a local startup lawyer in Malaysia so that it can work for a SAFE investment in a Malaysian startup. Therefore, a venture lawyer’s involvement in a SAFE round continues to stay relevant to ensure that the agreement is drafted correctly and reflects the commercial terms agreed between the investor and the startup.
Let’s take a quick look at how SAFE agreements can be used to raise funds in Malaysia.
SAFE 101: How does a SAFE work?
If you are a founder, your startup company and the investor (usually an angel or a venture fund) enter into a SAFE agreement. The usual terms that can be found in a SAFE will include:
- valuation caps
- discount rates
- maturity date
- liquidity event
- investment amount
Once these terms are agreed upon and the SAFE is signed by both sides, the investor sends the company the agreed investment amount. The company will then can use the funds based on the agreed funding usage (if it’s mentioned in the terms and conditions). The investor does not obtain the equity (usually preference shares) until an event listed in the SAFE agreement triggers the conversion (this is usually known as a ‘liquidity event’).
In the meantime, a SAFE that has not matured is treated like any other convertible security (like warrants or options).
Is SAFE agreement good for me as an entrepreneur and start-up founder?
Although SAFE is preferred by founders because it’s easy and fast, in my experience, a lot of the Malaysian founders we spoke with do not understand how SAFE terms actually work in practice. I am sure that you may also have read the horror stories out there on how founders ended up giving too many shares than they originally expected to investors in the end for failing to understand SAFE carefully.
Therefore, I am concerned that SAFE is not understood by both angels and founders. Also, you should ensure that you hire a competent company secretary that has worked with startups on a similar SAFE round so that you won’t have any hassles when the SAFE event is triggered to ensure that the equity is issued correctly (when the liquidity event in the SAFE is triggered in the future).
Are SAFE agreements good for investors?
Let’s assume that you’re an angel and that you’ve agreed to invest in a startup using a SAFE agreement.
As an angel, you are taking a huge gamble when you expect that a startup value will go up when you agree to invest in a startup using a SAFE agreement.
From a risk and reward perspective, you may have no clue what your company’s worth should be (which is the whole idea of a SAFE round in the first place!). Therefore, as an angel, you may be “motivated” and “incentivised” by the discount rate or valuation cap so that when there’s future equity priced round, you will be compensated against the initial risks taken earlier.
These are the ‘trade-offs” that you are making with the company’s founders and SAFE accomplishes this goal when you can get a lower issue price for your equity due to the discount rates or more shares based on the valuation cap compared to other investors that may be coming in at a later round (during the priced round).
So if you are an angel, you should do your research and consider carefully if SAFE is really the best way to invest in a startup and whether you’ve got the necessary risk appetite and the risks are worth it to put your money into a new startup.
What else do I need to know about SAFE?
Although Y Combinator has been using SAFE for its early stage investments in startups for as long as it was introduced in 2013, even Y Combinator’s SAFE financing documents have gone through multiple iterations and changes.
Also, it is worth highlighting that the Securities Commission of Malaysia, a regulating body in charge of the capital market including coming up with rules for a company offering securities and shares to the public has not issued any guidelines on the SAFE issuance like whether the SAFE is only limited to sophisticated investors (i.e. high net worth individuals). To date, the SC only mentioned that it is looking into coming up with more “regulatory clarity” on the matter.
Therefore, in the event of any dispute between a startup or an investor using a SAFE agreement at the moment, both parties would have to rely on the usual contract law to cover their rights and duties under the SAFE agreement.
As a legal counsel that deals a lot on both sides whether, with an investor or a startup founder, it may be tempting to use any ready-made SAFE template out there to get the funding in as soon as possible. g If you’re using a SAFE template, please make sure you engage a good local startup lawyer to take a look at it before signing off the SAFE document! It is crucial to ensure that the SAFE is enforceable and avoid potential legal issues in the future.