There are important issues that need to be carefully considered and discussed with respect to SAFE (Simple Agreement for Future Equity) agreements. (Yes, I know that’s redundant.) Let’s take a look:
Valuation Cap
This is arguably one of the most critical aspects of a SAFE. The valuation cap essentially sets the maximum valuation at which the SAFE can convert into equity during a future priced round. A higher valuation cap generally benefits the investor, as it allows them to potentially convert their SAFE at a lower price per share, thereby increasing their ownership stake in the company. Conversely, a lower valuation cap benefits the company by limiting the potential dilution to existing shareholders. Striking the right balance here is crucial, as both parties will want to negotiate a valuation cap that aligns with their respective interests and perceived value of the company.
Discount Rate
Some SAFEs also include a discount rate. This provision allows the investor to convert their SAFE into equity at a discounted price during a future priced round. For example, if the discount rate is 20%, and the company raises a priced equity round at $1 per share, the SAFE investor would be able to purchase shares at $0.80 per share. This essentially serves as an additional incentive for the investor, compensating them for the risk they took by investing early in the company.
Pro Rata Rights
Another key consideration is whether the SAFE includes pro rata rights. These rights give the investor the ability (but not the obligation) to participate in future financing rounds to maintain their ownership percentage. This can be a valuable protection for investors, as it prevents their stake from being diluted as the company raises additional capital. However, from the company’s perspective, pro rata rights can potentially complicate future fundraising efforts, as they may need to allocate a portion of each round to existing investors exercising these rights.
Most Favored Nation Clause
An MFN clause is designed to protect investors by ensuring that if the company issues SAFEs or other convertible securities on more favorable terms in the future, the existing SAFE holders will receive those same favorable terms. This provision aims to create a level playing field and prevent the company from offering better deals to new investors, which could potentially devalue the existing investors’ holdings.
Dissolution or Liquidation Preference
In the event of a dissolution or liquidation event before the SAFE has converted into equity, this provision determines how SAFE holders will be treated. Typically, SAFE holders will either be paid out like preferred shareholders (receiving a portion of the remaining assets) or treated as common shareholders (potentially receiving nothing). This is an important consideration, as it impacts the risk profile of the investment.
Conversion Triggers
SAFEs are designed to convert into equity shares, but the specific triggers for this conversion vary. Most commonly, SAFEs will convert upon a priced equity financing round, but some agreements may also include provisions for conversion in the event of an initial public offering (IPO) or acquisition. Understanding these conversion triggers is crucial, as they determine when the investor will finally receive their equity stake in the company.
Governance and Control
It’s important to note that SAFE holders generally do not have voting rights or control over the company until their SAFE converts into equity shares. This means that during the interim period, they have limited ability to influence the company’s decisions or direction. This lack of control can be a concern for some investors, particularly those who prefer to take a more active role in the companies they invest in.
Legal and Regulatory Considerations
It’s crucial to ensure that the SAFE agreement complies with all relevant securities laws and regulations. Failure to do so can expose both the company and the investor to potential legal issues and penalties. Working with experienced legal counsel is highly recommended to ensure that the agreement is properly structured and documented.
There are numerous issues to consider when it comes to SAFE agreements. Each can have significant implications for both the company and the investor; striking the right balance is essential. By thoroughly understanding and discussing these issues, both parties can make informed decisions and negotiate an agreement that aligns with their respective interests and goals.