What Is a SAFE Note?
SAFE notes (or Simple Agreement for Future Equity) are a simpler option than convertible notes. SAFE notes are documents that early-stage companies use to help raise pre-seed or seed capital. Essentially, a SAFE note acts as a legally binding promise to allow an investor to purchase a specified number of shares for an agreed-upon price at some point in the future. In simple terms, an investor will give a startup money and receive a promise to get equity, usually at a predetermined price when certain milestones are met.
Key Elements in a SAFE Note: Valuation Cap and Discount
SAFE notes have a few main terms that change how they finally convert to company shares, and they are:
- Discount: SAFEs sometimes apply discounts, commonly between 10% and 30%, on future converted equity. It means that the investor will be able to buy shares at a discount on the future financing. For instance, if the company offered SAFE note holders a 20% discount and reached a valuation of $10 million, with shares available to new investors at $10, the SAFE investors will be able to purchase their shares at $8, thus receiving a 20% discount.
- Valuation Cap: Alternative way for the investor to receive a better price per share than future investors is through a valuation cap. Valuation cap is a term in SAFE notes that sets the highest price per share, or cap, that can be used when setting the conversion price.
- Most-Favored Nation Provisions: In cases where there are multiple SAFEs, this term requires that the company informs the first SAFE about it, including the terms for the subsequent note. If the first SAFE holder finds the second SAFE’s terms to be more preferable, he or she can ask for the same terms.
- Pro-Rata Rights: Pro-rata, or participation rights, allow investors to invest additional funds so that they can keep their percentage of ownership during future equity financing.
- Four Types of SAFE notes:
- Valuation cap, no discount
- Discount, no valuation cap
- Valuation cap and discount
- MFN, no cap, no discount
To read about Pros & Cons of SAFEs and about comparison between SAFEs and Convertible notes follow the link below: