SAFE: What It Is, How It Works, and Its Clauses

Learn about the SAFE, an instrument created by Y Combinator to make fundraising easier for startups. In this article, you’ll learn everything you need to know about this convertible investment instrument and decide whether it’s the best option for your startup. 

This article, created in collaboration with Lazo, covers the following topics:

• What Is a SAFE?
• Types of SAFE
• Terms and conditions 
• Investor benefits
• Conversion events
• SAFE example
• Post-money SAFE
• Differences and similarities with convertible notes

What is a SAFE?

The SAFE (“Simple Agreement for Future Equity”) is a document created by YC so that startups can raise capital quickly and easily. Its purpose is to allow startups to receive money (investment) in exchange for giving up shares in the company in the future.

Generally, there are 2 most common types of SAFE: pre-money SAFE and post-money SAFE. In addition, each can have variations depending on the following clauses:

• Discount
• Valuation cap
• Most Favored Nation (MFN)

Additionally, the SAFE is one of several convertible investment instruments a startup can use to raise venture capital. 

Find the Y Combinator templates here.

SAFE clauses and terms

Below are some of the most common terms and conditions you’ll find in a SAFE.

• Investment amount and timing. The amount the investor will invest and when they will do so. The standard timing is immediately after the document is signed. Be very careful about signing a SAFE with an investor who doesn’t have the capital to fulfill that commitment.
• Valuation cap. The maximum valuation at which the investor will convert their investment into shares in the future. In other words, it sets the maximum price per share.
• Discount. The discount on the price per share that may be offered to the investor as a benefit for investing at an early stage. The standard percentage is usually 20%.
• Conversion event. Clauses that define when the investor can convert their investment into shares.
• Investor rights. Rights the investor will have access to as part of the investment.

Benefits for the investor

Why might an investor prefer to invest in your company through a SAFE rather than by purchasing shares directly? 

Given the following benefits a SAFE offers investors, this option may be more advantageous:

• The investor receives a preferential price compared with investors in future rounds, based on the cap or discount (whichever is more favorable to the investor).
• A benefit related to dividends.
• Preferential treatment in the event of liquidation. 

Additionally, both you as a startup and the investor will incur lower costs and spend less time closing the investment.

Conversion events

When will the investor receive shares in the company?

Also known as conversion events, these are the “triggers” that cause the SAFE to convert into shares in the company for the investor, based on their past investment. The most common conversion events are:

• Equity round—Series A. Also known as a “priced round,” this is when the company raises an investment round at an actual valuation, exchanging shares for money. This round typically takes place at Series A.
• Sale of the company. That is, in the case of an “exit.”
• IPO. Initial Public Offering, also known as going public.
• Company liquidation. That is, selling off the company’s assets as it winds down.

These events may also be referred to in the SAFE as liquidity events.

Now, what happens if none of these events occurs? The instrument does not convert, and the investor therefore does not become a shareholder in the company. 

SAFE: A practical example

What would the conversion of shares look like in practice for an investor who used a SAFE? Let’s look at an example.

1. In this example, the investor Brenda invested US $525K through a SAFE with a US $3M cap and a 20% discount.
2. Two years later, the startup raises a Series A round of US $1M at a US $5M cap.
3. At that point, the startup had 5M shares issued, resulting in a price per share of US $1 for the Series A investor.

How would investor Brenda convert her SAFE?

Applying the 20% discount to the price per share paid by the Series A investor, US $1, Brenda would pay US $.8 per share.

Brenda’s US $525K investment would buy 656,250 shares in the company, representing 13.1% of the company.

How would Brenda’s SAFE convert if she used the valuation cap instead of the discount?

1. Instead of dividing the 5M shares by the US $5M valuation at which the Series A investor will invest. 
2. We divide the 5M shares by the US $3M valuation cap Brenda signed with the startup. 
3. In this example, Brenda would pay US $.6 per share, which would allow her to buy 875,000 shares, or 17.5% of the company.

In the example above, Brenda would convert her SAFE using the valuation cap rather than the discount, since that conversion method gives her a greater benefit.

Remember that the investor will convert their SAFE according to the discount or the valuation cap, always choosing the term that represents the greater number of company shares.

SAFE vs. convertible note comparison

You’ve probably wondered: Which instrument should you use, a SAFE or a convertible note?

Both the SAFE and the convertible note are considered convertible investment instruments. However, there are always significant differences between them. We strongly recommend learning about these differences before choosing an instrument for your round. To explore the similarities and differences in more depth, we recommend watching the video.

Conclusions

In summary, the SAFE is a fast, inexpensive, and straightforward instrument that allows startups to raise money at an early stage and potentially achieve a higher valuation in their Series A.

Find the Y Combinator templates here.