SAFE Agreements: How They Work and When to Use Them

What Is a SAFE?

A SAFE (Simple Agreement for Future Equity) is an investment instrument created by Y Combinator in 2013 that has become the standard for pre-seed and seed-stage fundraising. Like a convertible note, a SAFE converts into equity at a future priced round. Unlike a convertible note, a SAFE is not debt. It has no interest rate, no maturity date, and no repayment obligation. It is simply a contractual right to receive equity in the future.

The simplicity of SAFEs has made them enormously popular. A standard SAFE is a 5-page document with minimal legal fees, enabling founders to close investments quickly and focus on building their company.

Types of SAFEs

Y Combinator publishes four standard SAFE templates:

• Valuation cap, no discount: The most common form. Conversion price is the lower of the cap or the price in the qualified financing
• Discount, no valuation cap: Investor receives a percentage discount to the next round's price
• Valuation cap and discount: Investor gets the better of the two conversion mechanisms
• MFN (Most Favored Nation), no cap or discount: Investor gets the benefit of the best terms offered to any subsequent SAFE investor

The post-money SAFE (introduced in 2018) has become the standard. Unlike the original pre-money SAFE, post-money SAFEs include the SAFE amount in the post-money valuation calculation, providing clearer dilution math.

SAFE vs. Convertible Note

Key differences between SAFEs and convertible notes:

• No interest: SAFEs do not accrue interest, so the investor converts at exactly the cap or discount amount
• No maturity date: There is no deadline by which conversion must occur, eliminating the risk of a maturity default
• Not debt: SAFEs do not appear as liabilities on the balance sheet
• Simpler documentation: Standard SAFE templates require minimal negotiation
• No board approval: Since SAFEs are not debt, they typically do not require board approval

Key Considerations for Founders

While SAFEs are founder-friendly in many ways, there are important considerations:

• Dilution math: Post-money SAFEs make dilution calculations clearer, but many founders still underestimate total dilution when raising on multiple SAFEs
• Pro-rata rights: Standard SAFEs include pro-rata rights, giving investors the right to maintain their ownership percentage in future rounds
• Conversion mechanics: Understand exactly how your SAFEs convert at different Series A valuation scenarios. Model the cap table at multiple price points
• Investor expectations: SAFE investors expect the same information rights and communication as equity investors, even if not contractually required

When to Use SAFEs

SAFEs are ideal for smaller pre-seed and seed rounds where speed and simplicity are priorities. For larger raises or more sophisticated investors who want protective provisions, a priced round may be more appropriate. Some international investors are unfamiliar with SAFEs and may prefer convertible notes or priced rounds. Always consider your investor base when choosing an instrument.