How do SAFE Notes Work?

A SAFE Note is a form of convertible security. Very similar to a convertible note, the investor pays cash today with the expectation that the cash turns into valuable stock later.

The term SAFE is an acronym for Simple Agreement for Future Equity, which was created by Y Combinator 2013 because startups were raising smaller amounts of money in advance of raising a larger round within less than a year. The SAFE Note was a simple and fast way to get the initial investors into the company and setting a “Safe” agreement to guarantee shares in the future priced round.

Similar to a Convertible Note, the SAFE helps founders raise money by incentivizing future stock in the company without putting an official valuation in the early stages. SAFE Notes offer an advantage to investors through discounts, valuation caps, or both. A discount reduces the price per share for the SAFE Note holder when the company actually starts selling stock. Discounts are fixed—typically common between 10% and 30% on the future priced shares.

Example - Investor buys into a SAFE at a 20% discount for $100k, on the following fundraising round, the company shares are priced at $100 per share. The investor will have his $100k converted into shares purchased at $80 per share and have an embedded 20% gain automatically.

A valuation cap is a more variable kind of discount. This could be the one “negotiated” part of the agreement. The investor wants a lower valuation cap to limit the share price the investor has to pay for the conversion. The founder often wants a higher valuation cap so the investor buys less shares at the time of conversion.

SAFE Note Investor Provesions

SAFE Notes will often contain additional investor provisions:

• Most Favored Nation Provision: When the startup issues multiple SAFEs, this provision term requires that the startup inform the first SAFE-holder about it, including the terms for the subsequent note. If the first SAFE-holder finds the second SAFE's terms to be more preferable, they can ask for the same terms.
• Pro-Rata Rights: Pro-rata, or participation rights, allow investors to invest additional funds so that they can keep their percentage of ownership during future equity financing.