The SAFE Agreement for start-ups and investors

Start-ups and investors today have various financing instruments available to raise capital and manage risk. One popular tool, particularly in the United States, but increasingly in the Netherlands as well, is the Simple Agreement for Future Equity (“SAFE Agreement”). A SAFE Agreement offers a flexible and relatively simple alternative to traditional share purchase agreements or convertible loans. In this article I explain what a SAFE Agreement entails, what its advantages and disadvantages are, and what are important points of interest for both start-ups and investors. In addition, I discuss how SAFE Agreements compare to other financing instruments and how they are applied in practice.

What is a SAFE Agreement?

A SAFE Agreement is an agreement between an investor and a startup in which the investor provides capital in exchange for the right to shares in the future. Unlike a convertible loan, there is no loan to repay or earn interest. Instead, the investment converts to equity at the time of a predetermined trigger event, such as another round of financing or an exit (e.g., an acquisition or IPO).

Who is a SAFE Agreement suitable for?

SAFE Agreements are particularly suitable for:

• Early-stage start-ups: For companies that do not yet have a clear business valuation because they are so young, a SAFE Agreement provides flexibility.
• Angel investors and seed investors: Investors willing to take risk in exchange for future equity can benefit from a SAFE.
• Entrepreneurs who need speed: The simple nature of the SAFE makes it possible to raise capital quickly without lengthy negotiations.

Benefits of a SAFE Agreement

A SAFE Agreement offers benefits to both start-ups and investors:

1. Simple and flexible: Drafting a SAFE Agreement is simpler and faster than traditional share purchase agreements. This makes the instrument attractive to start-ups that need funding quickly.
2. No fixed valuation required: A SAFE Agreement often involves a “valuation cap” (a maximum business valuation at which the investment is converted into shares) and/or a discount on the share price during a future funding round. This avoids complicated discussions about the exact valuation of the start-up at an early stage.
3. No repayment required: Because it is not a loan, a SAFE investment does not have to be repaid, at least not in cash. This reduces the pressure on the start-up’s cash flow.
4. Attractive to investors: Investors benefit from the opportunity to acquire shares at a favorable price, without directly assuming the risks and obligations of share ownership.

Disadvantages of a SAFE Agreement

While SAFE Agreements offer many advantages, there are also potential disadvantages and risks:

1. No interest or repayment: For investors, the lack of interest or repayment may be less attractive compared to a convertible loan.
2. Limited upfront rights: Investors have no control or other shareholder rights until the SAFE is converted into shares. This can be problematic if the start-up makes important decisions early on.
3. Complexity with multiple SAFEs: If a start-up issues multiple SAFEs, this can lead to share dilution and complexity in subsequent funding rounds. Transparent communication and careful management are crucial.
4. Trigger uncertainty: Investors must rely on future trigger events to cash in on their investment. If these do not occur, the value of their investment may remain unclear.

Comparison with other financing instruments

It is important to compare SAFE Agreements with other popular financing options, such as convertible loans and equity deals:

• Convertible loan: Unlike a SAFE, a convertible loan carries interest and a repayment obligation. This makes it more attractive to investors, but puts more pressure on the start-up.
• Equity issue: Issuing shares directly offers investors immediate shareholder rights, but requires an accurate business valuation and extensive documentation.

A SAFE Agreement thus represents a middle ground: simple, flexible and attractive to both parties at an early stage of financing.

Key concerns

For start-ups:

• Transparency: Ensure clear communication about the terms of SAFE Agreements, such as the valuation cap and any discounts.
• Future dilution: Consider the impact of SAFE Agreeements on future funding rounds and equity.
• Trigger events: Ensure that the conditions for conversion are realistic and well defined.

For investors:

• Due diligence: Examine the feasibility of the business strategy and the start-up’s ability to achieve a successful funding round or exit.
• Understanding terms: Pay attention to details such as valuation cap, conversion discount and any additional terms.
• Risk acceptance: Be aware of the risk that your investment may not pay off if trigger events do not occur.

Conclusion

The SAFE Agreement offers an innovative and flexible financing tool that can benefit start-ups and investors alike. Nevertheless, it is important to consider the terms carefully and take into account the specific risks that this instrument presents. Both start-ups and investors would do well to seek legal advice to ensure that the SAFE Agreement fits within their strategy and interests.
Our attorneys have extensive experience in drafting and reviewing SAFE Agreements. Please feel free to contact one of our attorneys by email, phone or fill out the contact form for a free initial consultation.  We are happy to think along with you and ready to assist you with your financing or investment strategy.