Introduction About the Simple Agreement for Future Equity
A Simple Agreement for Future Equity (SAFE) is a legal agreement /financing contract most commonly used either by startup companies/early-stage organizations to raise money in the rounds where seed funding is organized. This type of legal document is often regarded as a more founder-friendly approach since it guarantees up to a certain point that the startup will get the funding, in exchange for which they will continue developing the product they have promised. As compared to convertible notes, this is a more founder-friendly approach.
A Simple Agreement for Future Equity or SAFE also gives certain rights and guarantees to the seed investor for the money he or she is investing in. For example, by the contents of the agreement, the seed investor will receive equity when,
The startup is undergoing a Future Equity Financing, which is usually backed by institutional investing funding, also known as a Venture Capital. This round of funding is also known as Qualified Financing and or Next Equity Financing.
In the event that the founders of the company decide to sell it off, the seed investors will receive equity based on the number of funds they invested in the early rounds.
These incidents and many more, as such, are known as triggering events and are clearly outlined in the contents of the agreement so that all the parties are aware of the same.
Who Takes the Simple Agreement for Future Equity?
In the formation of a Simple Agreement for Future Equity or SAFE, there are usually two or more parties involved. The first party in the formation of the agreement is the founder of the founding team of the startup in context. The second part is the investor or the team of investors who have chosen to invest their money on the startup in exchange for certain equity.
Purpose of the Simple Agreement for Future Equity
Why Do You Need It?
The main purpose of this agreement and or financial equipment is to make sure that qualified early-stage startups can receive funding when they need it, and also, the investors who are investing their money be guaranteed substantial returns either in the form of equity or some other form in the company.
One of the most interesting aspects to know about this agreement is the fact that the price of the equity that the SAFE holders receive on investing in the company is much less as compared to the amount of equity that the VC investors receive. The amount of equity that each SAFE holder will receive is largely determined by either of the following factors.
- Discount rate
- The valuation Cap of the company in the context
Contents of the Simple Agreement for Future Equity
Parties Involved: In this legal agreement, there are usually two parties involved; the first being the founder of the founding team of the company and or startup in context and the second party being the investor and or the team of investors that have invested in the startup at the early stages.
Effective Date: This section of the agreement outlines the date from which this contract will stand legally binding and also the date on which the same can be dissolved.
Where does it Apply: This agreement is legally applicable within the boundaries of the state, city, or county where it was originally drawn at.
How to Draft the Simple Agreement for Future Equity?
SAFE can be drafted by simply following the steps mentioned below.
Organize a meeting both the parties and discuss upon the terms and conditions of the agreement, such as how much funds will be invested in the startup or company that is in context, the amount of equity that the investors will get in the company in exchange for the funds they are investing, and also how the product or service will be developed by the startup.
Once both parties have mutually agreed to all the terms and conditions, reach out to a lawyer and ask him to draw up a Simple Agreement for Future Equity (SAFE) according to the specifications discussed.
Get both the parties to sign the contract and get it registered in a house of law, as suggested by your lawyers.
One interesting aspect of having a Simple Agreement for Future Equity (SAFE) in place is the fact that the company has a guarantee that the funds will be invested in them at their time of need, and the investor also has the guarantee that the funds will be returned. In the event that your startup grows, you will need to invest more money in rounds, more commonly known as “priced investments.” In these rounds, the money is not invested by seed investors, rather by Venture Capitals, and is generally held in millions of dollars.
Once this round of investments is done, the equity that was held by the seed stage investors is converted into shares after taking into account the discount rate as well as the valuation cap. The shares can then be sold by the individual shareholders or even kept in their portfolio.
While negotiating the formation of a Simple Agreement for Future Equity (SAFE), it must be taken care that the individual interests of both parties must be addressed along with the collective cause.
As mentioned in an earlier paragraph, the amount of equity that the SAFE holders receive is much less as compared to those received by the VC investors. The main reason behind this being, the SAFE holders have all the same conversion features as the VC investors, but they lack the debt hallmark, which comes with convertible notes. The lack of a debt hallmark means that the SAFE agreement has:
No maturity date, which means that until and unless a trigger event takes place, a SAFE agreement remains valid indefinitely.
Accruing Interest: According to the contents of the SAFE agreement, the investors investing in startups at an early age only receive the right to convert their SAFEs into equities at a lower price, as compared to the investors in the subsequent rounds of funding. This is based on either the discount that is levied or the valuation cap that is set by the organization.
Benefits & Drawbacks of the Simple Agreement for Future Equity
The most significant benefits of having a Simple Agreement for Future Equity (SAFE) are as follows.
Benefits of Having a Simple Agreement for Future Equity (SAFE)
The contract clearly outlines the individual responsibilities, duties, and limitations and therefore makes sure that both parties are well aware of them at all points in time.
This is document acts as legal proof and thus can be produced in court if there is a need in the future.
Cons of Not Having a Simple Agreement for Future Equity (SAFE)
In the absence of a Simple Agreement for Future Equity (SAFE), neither of the parties have legal proof of an understanding taking place between two entities, and thus if the matter is ever brought to court, both parties stand to lose.
What Happens In Case of Violation?
In the case of violation of a Simple Agreement for Future Equity (SAFE), certain remedies come into effect, and in a few cases, the contract is dissolved, and a new set of terms and conditions are agreed upon.
The most common scenario of violation of this contract is when the company fails. In the event that the company fails, whatever money is left from the investment needs to be returned to the original investor or group of investors. If you are the founder, it is not your individual responsibility to return all the money; it is the responsibility of the company as a whole.
The SAFE agreement is a relatively new addition to the tools that are available to new startups as well as investors in order to upscale the startup ecosystem. The Simple Agreement for Future Equity or SAFE was first introduced by premium startup incubator Y combinator in the year 2013 and has since then been adopted globally by all incubators. Although over incubators in the industry have adopted the contents of SAFE and crafted similar forms for the startups, they are incubating but with different names.
Some of the most common iterations of the SAFE agreement include the following:
The convertible security proposed by a partner at the law firm of Wilson Sonsini Goodrich & Rosati.
The Keep it Simple Security (KISS) created by 500 Startups, another startup accelerator.
Some startup accelerators, as well as incubators, use a form of SAFE that has no discount as well as a valuation cap set, which means that after the second round of investment, the founders end up with more shares of the company.