SAFE NOTES
Originating in the US, the SAFE (Simple Agreement for Future Equity) note is a type of financial instrument commonly used in startup financing. It is an alternative to traditional convertible notes and serves as a simplified and standardized investment instrument for early-stage companies, without immediately determining the company's valuation. The SAFE note is a promise to issue shares to the investor at a future equity financing round, such as when the company raises funds through a priced equity round (e.g., Series A funding). Usually, the SAFE note does not specify an initial valuation for the company but includes a discount rate, which entitles the investor to receive shares at a discounted price compared to the price offered to future investors in the equity financing round. Unlike typical convertible loans, however, SAFE notes differ in that they have an indefinite duration and do not accrue interest. If no conversion or repayment event occurs, the investor stands to lose their investment. In the German financial context, SAFE notes can most closely be equated to a type of convertible loan, where specific triggers compel the conversion of the loan into equity or necessitate its repayment.
Note: SAFE notes are mostly used in the US.
- When SAFE notes are used to finance steward-owned companies, it should be documented that the conversion is only possible into equity instruments that comply with steward-ownership principles.
- SAFE Notes allow investors to postpone the valuation to a later point, typically until the next financing round, which offers some flexibility to the parties involved in the agreement, particularly regarding the valuation of the company and the timing of payout. However, there is a risk for founders that the financing becomes more expensive than they had originally planned if the valuation increases in the next financing round.
- Therefore be mindful when negotiating terms like a post-money valuation cap to prevent excessive dilution of early investors and founders if the company’s valuation increases in later rounds – while also ensuring a feasible buyback option.
- Pro rata rights are also commonly granted, ensuring investors can maintain – or not exceed – their proportional ownership as new shares are issued.
- SAFE notes generally do not come with the same set of investor rights and protections as equity shares or convertible notes.
- In some jurisdictions, SAFE Notes may not be legally recognized or enforceable.
- Conversion Trigger (SAFE notes convert into equity during a future financing round)
- Valuation Cap
- Conversion Discount –(investors receive a discount on the share price compared to new investors in the triggering funding round)
- Maturity Date & Repayment (unlike traditional convertible notes, SAFEs have no maturity date and do not require repayment if no triggering event occurs)
- Seniority & Security
- Early Exit or Buyout Options (some SAFE agreements outline buyout provisions, allowing the company to repurchase the investment under certain conditions)
