The Simple Agreement for Future Equity (SAFE) was popularised by Y Combinator (YC) in 2013 and has quickly become a ‘go-to’ instrument for startups seeking quick, flexible early-stage funding in the venture world.
However, failing to understand how SAFE works as a legal instrument may pose significant risks, especially for first-time angels.
How does a SAFE agreement work?
A SAFE (‘Simple Agreement for Future Equity’) is an easy way for startups to raise money without dealing with immediate valuations or shareholder responsibilities.
A SAFE usually includes terms like a valuation cap or discount rate, which give angels the chance to convert their investment into equity at a better price during a future event, like the next funding round. Unlike loans, SAFEs don’t have interest or a set repayment date, which makes them appealing for startups.
Until the SAFE converts, angels don’t have any ownership or voting rights in the company. But once the agreed event happens, the SAFE turns into equity based on the terms, letting angels receive shares in a startup at a lower price than future angels. This makes SAFEs a flexible and straightforward option for startups looking for quick and easy fundraising.
SAFEs can create uncertainty for angels
For first time angels, it’s important to understand that a SAFE is an early stage, risky investment, in many ways the antithesis of a “safe” investment. While SAFEs promise early access to high-growth ventures, they strip angels of traditional legal safeguards.
- No priced round: YC’s SAFEs usually have no maturity date, so they would likely sit in a startup’s books in practice “forever” without any legal requirement requiring the startup to do anything about them. If there is no qualified financing, or a sale event, the last closure for the SAFE angel may likely be a wind- up or liquidation, where the angel may be able to receive up to their original investment back. And that’s only if (a) the company has enough assets to liquidate, and (b) those assets are not taken up by secured and other unsecured creditors.
- No legal protections, no legal control: Until the SAFE converts, an angel usually does not have any of the rights that a shareholder would have (e.g. any voting rights or say in company decisions). A SAFE holder lacks voting rights, board seats, or liquidation preferences until a SAFE conversion in contrast to preference shareholders in a priced round. In liquidation events, they’re often subordinate to debt holders, risking total loss if the startup fails. According to Carta, a significant number of SAFEs signed by VCs also have side letters with common terms such as Most Favoured Nation (MFN) clauses, pro-rata rights, and information rights. Therefore, you may wish to get a startup lawyer to draft a side letter if you want additional rights beyond those outlined in the standard SAFE.
- Complex cap table and conversion roulette: In our experience, as more SAFEs convert into equity and multiple SAFEs with varying terms are in play, the startup’s capitalisation table (‘cap table’) can end up becoming complex. If you are unfamiliar with cap tables, you may want to read up about “cap table cramming” and how later SAFEs with better terms may dilute your stake.
The legal gray zone
In 2021, after transitioning the SAFE agreement to be based on a post-money valuation, YC also began publishing international versions of the SAFE to address jurisdictional issues. To date, versions are available for Canada, the Cayman Islands, and Singapore, with clear warnings to seek local legal advice.
Therefore, the YC’s SAFE template may usually require extensive customisations by a startup lawyer with direct experience in securities law. Therefore, you must make sure that the SAFE is customised for your jurisdiction and that you’re complying with applicable securities laws in the country where the startup is domiciled. For example, a Malaysian startup must still comply with local Malaysian securities laws.
In 2022, Singapore Academy of Law and Singapore Venture and Private Capital Association introduced the Convertible Agreement Regarding Equity (CARE), within the Venture Capital Investment Model Agreements (VIMA) as a local alternative to the YC’ SAFE agreement, to get more venture funding for startups.
In my past experience as a startup lawyer, issues may arise when counterparties may be unfamiliar, especially over conversion mechanics (adding further to closing timeline compared to traditional equity structures). For instance, SAFE shares to be issued to a startup must be properly allotted and issued upon conversion, including setting the correct issue price at the subscription date, obtaining the necessary preemptive rights waiver from the existing shareholders to filing the necessary share lodgement returns to the registrar by the company secretary.
Final thoughts
Angels must not get fooled by the term “simple” as there are still complicated mechanics to work through. Therefore, angels should seek legal advice before seeking to deploy capital using SAFE. As with all “standard” forms, one size doesn’t fit all and there are aspects of the YC’s SAFE that needs to be fixed each and every time one is used.
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A version of this article was originally published on e27.