What is a SAFE agreement?
What is a SAFE agreement?
Any start-up needs money to start activities and implement its goals. And at this stage of development, a problem arises. It is difficult to obtain funding, and therefore a startup has to agree to the terms of the investor, which are often unprofitable for a startup. And at this stage, the SAFE agreement comes to the rescue.
SAFE or simple agreement for future equity is a convertible loan without an element of debt. According to SAFE, the investor agrees to make a cash payment other than a loan to the company in exchange for the contractual right to convert that amount into shares at a predetermined specified event. Such an event could be the closing of a new round of investment.
How does the SAFE agreement work?
Under the SAFE agreement, the investor offers money to the startup in exchange for shares. The number of shares received by an investor depends on the amount of the advance payment and the price of the shares.
The startup company (or other company) and the investor enter into an agreement. They discuss things like:
- Valuation cap is the limit on the maximum valuation of the company at which the investor receives shares upon conversion;
- Amount of investment. (Investment amount);
- Discounts - under the SAFE agreement, the investor gets the right to purchase shares with a discount of 5 to 30 percent;
- Maturity date.
After agreeing on the terms and signing the SAFE by both parties, the investor sends the agreed funds to the company. The company uses funds in accordance with the relevant conditions. The investor does not receive capital (preferred shares of the SAFE agreement) until the event specified in the SAFE agreement initiates the conversion.
Meanwhile, a SAFE agreement that has not expired is treated like any other convertible security (for example, options).
Benefits of a SAFE agreement
Raising capital with a SAFE agreement offers many advantages over other forms of capital raising, including:
- With a SAFE agreement, it is easier and faster to come to an agreement. There is no need to agree on a preliminary valuation (although the investor may want to agree on a valuation ceiling) and the only document required is a SAFE agreement;
- A SAFE agreement is easier to approve than a convertible loan because it has fewer terms and conditions. A convertible loan is a debt instrument, so the parties must agree on the usual terms of the debt, including:
- credit term;
- whether the founders have to pay interest on the loan;
- whether the startup should provide collateral for the loan.
- The simplicity of a SAFE contract usually means lower costs (especially legal costs);
- The founders do not pay interest under the SAFE agreement and therefore avoid the difficulties associated with the conversion of interest into equity;
- SAFE is not a debt instrument. As such, they are not regulated as debt and do not pose insolvency threats to your startup.
- For an investor, a SAFE agreement usually means the opportunity to receive a discount on the purchase of shares, rather than from other investors who have not entered into a SAFE agreement. This discount can range from 5 to 30%.
The SAFE agreement is used by startups specifically as a new way to attract investment. But they can make a difference in the growth of a startup because they:
- relatively easy to create and implement;
- do not charge interest like a loan;
- offers flexibility in how a company can raise funds.
These three points can play an important role in attracting investors to the company. They also come with less risk that often accompanies other types of investments. In other words, the SAFE agreement is a kind of problem-solving tool for start-up companies. If you have any problems or questions during the execution of the SAFE agreement, the specialists of A4 Law Firm are ready to provide you with legal assistance in this matter.
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