Simple Agreement for Future Equity (SAFE) Lawyer
Chicago SAFE note Attorney
However, contrary to what their name implies, SAFE notes are neither completely safe nor simple, nor do they guarantee future equity. There are plenty of considerations you should analyze before entering a SAFE Agreement to ensure your startup will have a successful start or your investment will be profitable.
SAFE Agreements work by allowing company founders to raise capital for their companies before a valuation can be determined. An investor’s future equity is contingent on an event or time and can be unpredictable. Investors also do not get voting rights until the SAFE Agreement terms are triggered. However, like with contracts, everything is negotiable, including an investor asking for a right to vote on certain matters or to be sell back the future equity to the company.
Our Oak Brook corporate attorneys at Motiva Business Law help company founders and entrepreneurs effectively assess the terms of the agreement, identify potential risks, and negotiate favorable terms that align with their investment objectives.
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How do SAFE Agreements Work?
- During the seed financing rounds, an investor enters a SAFE agreement and provides venture capital in exchange for future equity.
- Using the original investment, the business owner builds a startup company
- After the performance of the business has improved and the specified trigger event occurs, the startup company gets a post-money valuation
- Based on the previous valuation, the business owner defines the new price per share for the startup in this new round.
- The SAFE converts into equity and capital converts into shares of preferred stock in the company. Based on the terms of the SAFE Agreement, those investors can receive lower conversion prices than future investors, according to the discount rate and valuation cap.
SAFE terms to look out for:
- Investment amount: Indicates how much money the venture capitalist will inject into the startup business.
- Discount: Typically expressed as a percentage, an investor can benefit from purchasing shares at a lower cost than new investors during a future priced round. For example, if the SAFE includes a 20% discount and the new investors purchase shares at $10, the SAFE holder would convert their investment at $8 per share.
- Valuation cap: Designed to ensure the investor converts their investment into equity at a favorable price, a valuation cap sets a maximum pre-money valuation at which the investment converts into equity during the future financing round. If the cap is lower than the market valuation, then the SAFE investor will convert at more favorable terms than the new equity investors.
- Most Favored Nation Clause: Under an MFN clause, the SAFE investors will ensure to obtain the same benefits if future investors receive more favorable terms.
- Pre-money or post-money SAFE: When appraising a business, a pre-money valuation will define the worth of a company before new investor money, while a post-money valuation will show the value of the company after receiving outside funding.
- Conversion trigger: The event that will cause the investment to convert into equity.
Considerations Before Entering a Simple Agreement for Future Equity
SAFEs are not common stock: As a SAFE investor, you will not get an equity stake in return. You will not be protected under the securities law and may not give you any kind of decision-making power over the company.
SAFEs are subject to triggering events: You will receive a future equity stake based on the amount you invested only if the specified conversion trigger event occurs. Sometimes, SAFEs may not be triggered. An example of how this could happen is that if a company makes enough money so that it never needs capital again, the SAFE will not be converted.
Understand your rights: Ensure to know how your investment converts into equity and how many shares you will receive (or give up) according to the investment, what happens to the capital if the company dissolves, and if the investor will have voting or repurchase rights.
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How can our SAFE attorneys help you?
- Ensure that the SAFE is the best funding option for the startup business
- Understand the implications of the agreement and protect your rights.
- Negotiate the most favorable terms regarding valuation caps, discount rates, and conversion mechanics.
- Mitigate the risks of entering the agreement.
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Simple Agreement for Future Equity (SAFE) FAQ
- Agility in the process: Since there is not so much room for negotiation, SAFEs can typically make the transaction progress faster than a priced round. The simplicity of the contract can also enable lower professional fees.
- Attractive to investors: Protected by the valuation cap or conversion discount, investors may be more willing to take a risk on your company.
- No interest rates or maturity dates: Since SAFEs are not debt instruments as convertible notes are, startup owners do not have to worry about interest rates and maturity dates. This means that there is no debt to be repaid and the SAFE remains outstanding indefinitely until a triggering event occurs.
- Uncertainty: Future valuations may not meet the SAFE investors’ expectations, and they may feel they’ve overpaid if the appraisal is lower than anticipated at the conversion event.
- No equity stakes: A SAFE investor does not have the rights of a stockholder until the specified triggering event occurs, which means they are not protected under securities law, and they typically do not have voting rights or control over the company until the conversion occurs.
- Dilution: As a result of the issuance of additional shares in future priced rounds, existing shareholders risk the reduction of ownership.