What is A SAFE Agreement?

If you’re a startup founder, raising capital is a critical milestone on your journey. You’ve likely come across the term "SAFE agreement" and wondered what it’s all about. A SAFE (Simple Agreement for Future Equity) is a founder-friendly way to secure early-stage funding without the complexities of setting a valuation or issuing shares upfront. In this guide, I’ll break down what a SAFE is, how it works, and why it’s become a go-to tool for startups.

What Is a SAFE Agreement?

SAFE agreements are legal contracts that allow startups to raise money in exchange for future equity. Introduced by Y Combinator in 2013, SAFEs simplify the fundraising process by deferring the issuance of equity until a later funding round or a liquidity event like an acquisition. Investors give money now and receive equity in the future based on pre-agreed terms.

Unlike traditional convertible notes, SAFEs are not debt instruments. There’s no interest rate or maturity date, which means less pressure on founders to repay or convert by a specific deadline.

Key Features of a SAFE Agreement

Valuation Cap

The valuation cap sets the maximum company valuation at which the SAFE converts into equity. It rewards early investors by giving them a better price per share if your startup’s valuation grows significantly.

Discount Rate

The discount rate (typically 10-20%) gives investors a lower price per share compared to future investors in the next funding round. This incentivizes early investment.

Pro-Rata Rights

Some SAFEs include pro-rata rights, allowing investors to maintain their ownership percentage by participating in future funding rounds. This is especially attractive to investors who want to stay involved as your startup scales.

Trigger Events

SAFEs convert into equity when a specific event occurs, such as a future equity financing round, an acquisition, or an IPO. The terms are flexible and designed to adapt to the startup’s growth.

Why Use a SAFE Agreement?

Simplified Legal Process

SAFEs are shorter and less complicated than traditional equity financing or convertible notes, saving time and legal fees.

Founder-Friendly Terms

With no repayment obligation or interest accrual, SAFEs reduce financial pressure on founders during the early stages.

Flexible for Early-Stage Startups

SAFEs are ideal for startups that lack a clear valuation or need quick access to capital to hit critical milestones.

Attractive to Investors

By offering a valuation cap and discount rate, SAFEs reward early-stage investors for their risk while keeping the terms straightforward.

How to Structure a SAFE Agreement

Negotiate a Fair Valuation Cap

Set a valuation cap that balances investor incentives with your company’s growth potential. Too low, and you risk excessive dilution; too high, and it might deter investors.

Decide on Discount Rates

Discount rates are standard but not mandatory. If you’re offering a lower valuation cap, you might skip the discount to simplify terms.

Customize Pro-Rata Rights

Discuss with your investors whether pro-rata rights should be included. While beneficial for them, it could lead to additional dilution for you in future rounds.

Use a Standard Template

YC provides a free SAFE template that’s widely accepted by investors. Starting with this template ensures you’re using an industry-standard agreement.

SAFE Agreements vs. Convertible Notes

Key Differences

1. Debt vs. Equity: Convertible notes are debt instruments with interest and a maturity date. SAFEs are equity agreements with no debt obligation.
2. Simplicity: SAFEs have fewer moving parts, making them quicker to execute.
3. Flexibility: SAFEs don’t pressure founders with repayment timelines or accrued interest.

Which One Should You Choose?

• Use SAFEs if you’re raising funds from angel investors or participating in a structured accelerator program like YC.
• Opt for convertible notes if investors insist on the security of debt or if your legal team advises it based on your startup’s situation.

When to Use a SAFE Agreement

SAFEs are best suited for:

1. Pre-Seed or Seed Rounds: When your company is too early to justify a formal valuation.
2. Accelerator Programs: SAFEs are commonly used in YC and similar programs to streamline funding.
3. Quick Capital Needs: When you need to close funding fast without the legal complexities of equity deals.

Challenges of SAFE Agreements

Potential Dilution

Multiple SAFEs with low valuation caps can lead to significant dilution when they convert. Keeping your fundraising rounds organized and well-documented helps mitigate this risk.

Investor Education

Not all investors are familiar with SAFEs, especially outside of tech hubs. You may need to spend time explaining how they work and why they’re beneficial.

Uncertain Timing

Since SAFEs convert during a trigger event, investors might wait years to see their equity materialize. Ensure you communicate timelines clearly to manage expectations.

Tools to Manage SAFEs

Keeping track of SAFEs and their terms is essential. Here are some tools to help:

1. Carta: Tracks SAFEs, cap tables, and equity conversion scenarios.
2. Pulley: Simplifies cap table management and SAFEs for startups.
3. Gust Equity Management: Offers SAFE tracking as part of a broader equity management platform.

Real-World Example

Let’s say you’re building an AI-powered marketplace for healthcare services. You raise $500,000 using SAFEs with a $5 million valuation cap and a 15% discount. A year later, you close a $3 million Series A at a $10 million valuation.

Your SAFE investors’ equity converts at the $5 million cap, giving them a significant upside compared to Series A investors. The process is seamless, and you avoid the debt obligations of a convertible note.

Common Misconceptions About SAFE Agreements

“SAFEs Are Only for YC Startups”

While SAFEs were pioneered by Y Combinator, they’re now widely used across the startup ecosystem. Any early-stage founder can use a SAFE to raise capital, whether or not they’re part of an accelerator program.

“SAFEs Eliminate the Need for Negotiation”

Although SAFEs are simpler than equity financing, there’s still room for negotiation. Terms like valuation caps, discount rates, and pro-rata rights often require discussion and alignment between founders and investors.

“SAFEs Convert Immediately After a Funding Round”

SAFEs convert only when a qualifying event occurs. This is usually a priced equity round, but the timing depends on the terms in the SAFE agreement. Investors might need to wait months or even years to see their investment materialize as equity.

Advanced Strategies for Using SAFEs

Tiered Valuation Caps

To attract a range of investors, consider offering tiered valuation caps based on investment size. For example, smaller investments might convert at a higher cap, while larger ones get a more favorable rate. This incentivizes larger contributions while keeping the structure transparent.

Rolling SAFE Closures

Instead of setting a hard deadline for your fundraising round, keep it open for a limited time to accommodate ongoing interest. This approach allows you to bring in new investors without delaying current operations.

Using SAFEs for Bridge Funding

If you’re between funding rounds and need a quick infusion of capital, SAFEs can be an efficient way to secure bridge funding without disrupting your long-term plans.

Combining SAFEs with Revenue Milestones

Some startups tie SAFE terms to specific revenue or traction milestones, making the investment terms more dynamic and aligned with performance. This can be a compelling way to attract results-driven investors.

Managing SAFE Agreements for Multiple Investors

Streamlined Onboarding

When raising funds from multiple investors, use a standardized SAFE template to ensure consistency. Avoid creating custom terms for each investor, as this can lead to legal and operational headaches.

Tracking Valuation Caps and Conversion Scenarios

Keep detailed records of each investor’s SAFE terms, including valuation caps and pro-rata rights. Tools like Carta or Pulley can simplify this process, ensuring you’re prepared when a trigger event occurs.

Transparent Communication

Keep your SAFE investors updated on your progress, including key metrics, milestones, and upcoming funding rounds. Clear communication builds trust and keeps them engaged in your journey.

SAFE Agreements in International Contexts

Global Adoption

While SAFEs originated in the U.S., they’re now used worldwide. However, some countries have legal restrictions or tax implications for SAFEs. For instance, European startups may need to adjust terms to comply with local regulations.

Currency Considerations

If raising funds from international investors, consider the impact of currency fluctuations on the investment. You may want to denominate the SAFE in a stable currency like USD or EUR to minimize uncertainty.

Cross-Border Legal Compliance

Ensure your SAFE agreements comply with the laws of the investor’s country. This might involve adapting the standard YC template or consulting with legal experts familiar with cross-border agreements.

Post-Trigger Event Planning

Handling Partial Conversions

In some cases, not all SAFEs convert during a funding round, especially if certain investors choose not to participate in the round. Plan for how these remaining SAFEs will be managed to avoid complications later.

Addressing Investor Concerns Post-Conversion

Once SAFEs convert, investors become equity holders. Be prepared to answer questions about voting rights, board participation, and future funding strategies to maintain a strong relationship with your new shareholders.

Updating the Cap Table

After SAFEs convert, your cap table must reflect the updated ownership structure. This step is critical for transparency, especially as you prepare for subsequent funding rounds or potential acquisitions.

Horizon-Labs.co: Your Partner in Building and Scaling

At Horizon-Labs.co, we’re not just a product development agency—we’re your strategic partner in bringing your startup vision to life. If you’re using SAFEs to raise capital, our experienced team can help you turn that funding into actionable outcomes. From building MVPs to scaling engineering teams, we’ve got you covered.

Get in touch with us at info@horizon-labs.co or schedule a consultation at horizon-labs.co/contact. Let’s build better, faster, and smarter together!

Frequently Asked Questions (FAQs) about SAFE Agreements:

Q: Can I use a SAFE agreement to raise funds from multiple investors?

A: Yes, SAFE agreements are designed to be used with multiple investors. Each investor receives their own SAFE agreement, and the terms (such as valuation cap and discount rate) can either be standardized or customized depending on your preferences and their investment size.

Q: Do SAFE agreements require a minimum funding amount to trigger conversion?

A: Some SAFE agreements include a clause specifying a minimum funding amount for the next round (a "qualified financing") to trigger conversion. This ensures that the SAFE converts only when the company secures a substantial funding round.

Q: What happens if my startup never raises a priced equity round?

A: If your startup never raises a priced equity round, the SAFE agreement may include alternative terms for conversion or resolution, such as converting at a predetermined valuation or during a liquidity event like an acquisition.

Q: Can a SAFE agreement include a time limit for conversion?

A: Unlike convertible notes, SAFE agreements typically don’t include a maturity date. However, you can negotiate a "long-stop date," which sets a maximum time limit for conversion or triggers alternative terms after a certain period.

Q: How does a SAFE agreement impact employee equity pools?

A: SAFE agreements don’t immediately affect your employee equity pool. However, when the SAFEs convert into equity, they can dilute the pool. It’s a good idea to account for this potential dilution when structuring your equity pool.

Q: Are SAFE agreements legally binding across all jurisdictions?

A: SAFE agreements are widely accepted in the U.S. but may require modification to comply with legal and tax regulations in other countries. Consult with local legal counsel to ensure compliance if you’re using SAFEs with international investors.

Q: Can SAFEs include investor protections like anti-dilution rights?

A: Standard SAFEs don’t include anti-dilution rights, but these can be negotiated separately if an investor requests them. However, granting such rights can complicate future funding rounds, so weigh this carefully.

Q: Is it possible to raise funds using both SAFEs and convertible notes?

A: Yes, but managing both instruments simultaneously can complicate your cap table and future equity structure. It’s essential to clearly track the terms of each instrument to avoid conflicts during a funding round.

Q: Can I issue SAFEs at different valuation caps to different investors?

A: Yes, startups often issue SAFEs with tiered valuation caps to incentivize larger investments. For example, an investor contributing $500,000 might receive a lower valuation cap compared to one investing $50,000.

Q: Are SAFE agreements limited to specific industries?

A: No, SAFE agreements can be used across various industries. While they’re most common in tech startups, any company looking for a straightforward fundraising tool can benefit from SAFEs.

Q: How do SAFEs work in the event of an acquisition?

A: If your company is acquired before the SAFEs convert, most agreements stipulate that investors receive either their initial investment back or convert into equity based on the acquisition valuation, depending on the terms.

Q: Do investors gain any control over the company through SAFEs?

A: SAFEs typically don’t grant investors voting rights or control over company decisions until they convert into equity. Even after conversion, voting rights depend on the class of shares issued during the equity round.

Q: How are SAFEs treated for tax purposes?

A: SAFEs are generally treated as equity instruments for tax purposes, but the specific treatment may vary depending on the jurisdiction. Investors and startups should consult tax professionals for guidance.

Q: Can I amend a SAFE agreement after it’s signed?

A: Yes, but amendments require mutual agreement between the startup and the investor. Any changes should be documented formally to avoid future disputes.

Q: Are SAFEs a good fit for bridge financing?

A: Yes, SAFEs are an excellent tool for bridge financing, as they allow you to raise funds quickly without renegotiating equity terms for a small interim round. This helps maintain momentum while preparing for a larger funding round.

Q: Can SAFEs be used for follow-on funding rounds?

A: Yes, SAFEs can be used for follow-on rounds, but it’s important to clearly track each SAFE’s terms, such as valuation caps and discount rates. Multiple SAFEs across different rounds can complicate your cap table, so careful management is essential.

Q: Are SAFEs suitable for startups without any revenue?

A: Absolutely. SAFEs are often used by early-stage startups that are pre-revenue or still developing their product. They’re particularly helpful when you need to raise funds without the complexity of setting a valuation.

Q: What happens if I want to close a funding round before all SAFEs are converted?

A: SAFEs typically convert during the next priced equity round or a qualifying trigger event. If some SAFEs remain unconverted, their terms remain valid and will convert in the next applicable event or under agreed alternative terms.

Q: Can SAFEs have different trigger events for conversion?

A: Yes, the terms of a SAFE can include various trigger events, such as a liquidity event, acquisition, or a predetermined time-based milestone. These terms can be negotiated with investors to provide flexibility.

Q: How do SAFEs impact pre-existing shareholders?

A: SAFEs can dilute pre-existing shareholders when they convert into equity. It’s crucial to communicate potential dilution to stakeholders and account for it when structuring future funding rounds.

Q: Can a SAFE be repaid instead of converting into equity?

A: SAFEs are not debt instruments, so repayment is not standard. However, some SAFEs include provisions that allow investors to be repaid in cash during a liquidity event if equity conversion is not feasible.

Q: Are SAFEs appropriate for raising large amounts of capital?

A: SAFEs are best suited for smaller, early-stage funding rounds. For larger raises, traditional equity financing or hybrid instruments might be more appropriate, as they provide more clarity on ownership stakes.

Q: Do SAFEs require board approval?

A: Yes, issuing SAFEs typically requires board approval. This ensures that the terms align with the company’s strategic goals and existing agreements with shareholders.

Q: Can SAFEs include revenue-sharing clauses?

A: While not common, SAFEs can be customized to include revenue-sharing or profit-sharing clauses if both parties agree. These are typically more common in industries like entertainment or creative ventures.

Q: How does a startup handle SAFEs during a down round?

A: In a down round (when your valuation decreases), SAFEs convert based on their agreed valuation cap or discount, potentially leading to higher dilution for founders. Carefully planning and negotiating SAFEs can help mitigate risks in these scenarios.

Q: Are SAFEs transferable to other investors?

A: SAFEs often include restrictions on transferability, requiring the company’s approval before an investor can transfer their SAFE to another party. This prevents unexpected changes in your investor base.

Q: Can SAFEs be issued to institutional investors?

A: Yes, institutional investors often participate in SAFE agreements, especially in pre-seed and seed rounds. However, they may negotiate for additional terms, such as board seats or enhanced rights.

Q: What happens if a SAFE investor doesn’t want to participate in the next round?

A: If a SAFE investor chooses not to participate in the next funding round, their SAFE still converts into equity based on the agreed terms. They forfeit any pro-rata rights tied to that round.

Q: How do SAFEs work in jurisdictions with strict securities laws?

A: In regions with strict securities laws, SAFEs may require adjustments to comply with local regulations. This could include additional disclosures, investor accreditation requirements, or registration with regulatory authorities.

Q: Can a SAFE agreement be revoked after issuance?

A: Once signed, a SAFE agreement is legally binding. Revoking it requires mutual consent and formal amendment or termination, typically accompanied by a refund of the investor’s contribution.

Q: What’s the difference between pre-money and post-money SAFEs?

A: Pre-money SAFEs calculate ownership stakes before new funding is added, while post-money SAFEs calculate after new funding. Post-money SAFEs provide more clarity on ownership dilution, making them the preferred option for many investors.