SAFE - what it is and how it works
In the field of investing and financing start-ups, there are many different forms of agreements that allow investors to provide funds and at the same time acquire a stake in the company. Among the most popular are the CLA (Convertible Loan Agreement) and the SAFE (Simple Agreement for Future Equity). In this article, we will focus on the second type of contract, the SAFE. SAFE is widely used in the USA and Canada, but is not yet widespread in the Czech Republic.
What does SAFE mean?
SAFE, or Simple Agreement for Future Equity, is a financial instrument used to invest in start-ups. Unlike traditional investment agreements such as a conversion loan agreement (CLA), a SAFE does not contain a debt element or a maturity date. The investor agrees to make a payment to the start-up in exchange for the contractual right to convert that amount into shares or equity in the event of a pre-agreed trigger event, which is almost always the acquisition of an equity stake by someone else (notably another investor).
SAFE also secures the investment without the need to determine the value of the company at the time of investment. For a start-up, this type of contract is thus very advantageous precisely because of the absence of the debt element (and the associated interest) and without the need to value the company. It is also simpler (and cheaper) to prepare than a CLA.
Valuation cap and Discount
When using a SAFE, a valuation cap and discount are usually set out in the contract. The valuation cap determines the maximum price at which the investor will convert his investment into shares or equity in the start-up. The discount is usually a percentage discount that the investor receives on the price of the shares. For a better understanding, below are examples of how both instruments work.
Valuation cap
Let's imagine that Investor A invests CZK 1 million in a start-up using SAFE. A valuation cap of CZK 5 million is embedded in the contract.
Some time later, Investor B appears and also invests CZK 1 million in the start-up at a valuation of CZK 10 million.
Since a triggering event has occurred (acquisition of an equity stake by a third party - a new investor), Investor A is entitled to convert his investment into shares. Investor A has a contractually set valuation cap of CZK 5 million, compared to Investor B who makes the investment at a company value of CZK 10 million.
Thus, when Investor A converts, the company will be treated as if it were worth CZK 5 million, i.e. instead of 1 million shares/units, Investor A will receive 2 million shares/units.
Discount
Let us imagine the same situation as in the previous case. However, the contract with Investor A provides for a 20% discount, there is no valuation cap. Later, Investor B joins the company and agrees to buy the shares/shares at a price of CZK 1 per share/share, so the conversion trigger event of Investor A occurs again. However, Investor A will not have 1 share/share for CZK 1 as Investor B, but for CZK 0.80 thanks to the discount.
If it is the case that both the valuation cap and the discount appear in the SAFE, the more advantageous for the investor will usually be used.
Conclusion
It is quite clear that SAFE is an interesting form of financing for start-ups, which has its advantages and disadvantages compared to CLA. However, each agreement is individual and both the investor and the start-up should carefully consider which form of financing is most suitable for them.