What is a SAFE Note?
A SAFE (Simple Agreement for Future Equity) is a type of investment vehicle that is often used by startups to raise capital. It is similar to a convertible note in that it allows investors to provide funding to a company in exchange for the potential future equity in the company.
History of the SAFE Note begins with YCombinator in 2013
It was created by Y Combinator, in 2013. The goal of the SAFE was to provide a simpler and more flexible alternative to traditional convertible notes for startups raising seed funding.
The SAFE was designed to be a standardized investment vehicle that could be used by startups to quickly and easily raise capital from investors and eliminated many of the complexities and legal costs associated with traditional convertible notes, making it a more attractive option for both startups and investors.
Since its creation, the SAFE has become a popular investment vehicle for startups, and has been used by many companies to raise seed funding. Y Combinator continues to be a major advocate for the use of SAFEs in startup financing, and has played a key role in promoting and popularizing the use of this investment vehicle.
SAFE Note conversion example
- A startup raises $500,000 through the sale of SAFE notes to investors. The terms of the SAFE specify that the notes will convert into equity in the company at a future date, based on the company’s valuation at the time of conversion.
- After two years, the startup has grown significantly and is ready to raise additional funding through a Series A round of financing. The company’s valuation at this time is $10 million.
- As part of the Series A financing, the terms of the SAFE notes require that they be converted into equity in the company at a conversion price of $1 per share. This means that the investors who provided funding through the SAFE notes will receive a total of 500,000 shares in the company (the amount they invested divided by the conversion price).
- The investors now own a 5% equity stake in the company (500,000 shares / 10,000,000 total shares). They can hold on to these shares and potentially see a return on their investment if the company continues to grow and the value of the shares increases.
In this example, the conversion of the SAFE notes allowed the investors to receive equity in the company based on the company’s current valuation. This provided them with the potential to see a return on their investment if the company continues to grow and succeed.
It’s important to note that the terms of a SAFE can vary, and this is just one possible example of how a SAFE note may convert. The specific terms of any SAFE will determine how and when the notes will convert into equity in the company.
How is a SAFE Note different than a convertible note?
Unlike a convertible note, which typically has a fixed conversion price, the conversion price of a SAFE is determined based on the valuation of the company at the time of conversion. This means that the investors’ potential equity stake in the company may vary depending on the company’s valuation when the SAFE is converted.
Another key difference between a SAFE and a convertible note is that a SAFE does not accrue interest or have a maturity date. This makes it a simpler and more flexible investment option for startups and investors.
Overall, a SAFE is a useful tool for startups looking to raise capital without the added complexity of a convertible note. It allows investors to provide funding in exchange for the potential future equity in the company, while also providing flexibility and simplicity for both parties.
SAFE Note FAQs
If a SAFE note never converts, the investors who provided funding through the SAFE will not receive any equity in the company. The terms of the SAFE will typically specify what will happen in this situation, but in most cases the investors will simply lose the money they invested through the SAFE.
In some cases, the terms of the SAFE may allow for the investors to receive some form of compensation if the SAFE does not convert. For example, the SAFE may include provisions for the repayment of a portion of the investment, or the investors may be entitled to receive some form of preferred stock or other security.
In the context of a SAFE (Simple Agreement for Future Equity), dilution can occur when the SAFE converts into equity in the company. When this happens, the investors who provided funding through the SAFE will receive a certain number of shares in the company based on the conversion terms of the SAFE. This will increase the total number of shares outstanding, which will dilute the ownership stakes of the existing shareholders.
For example, if a company has 10,000,000 shares outstanding and raises $500,000 through the sale of SAFE notes, and the SAFE converts at a price of $1 per share, the company will issue an additional 500,000 shares to the SAFE investors. This will increase the total number of shares outstanding to 10,500,000, diluting the ownership stakes of the existing shareholders by 5%.
A SAFE may or may not have a cap, depending on the terms of the specific SAFE. A cap is a maximum conversion price that is specified in the terms of the SAFE, and it is used to limit the potential equity stake of the investors in the company.
For example, if a SAFE has a cap of $1 per share and the investors provide $500,000 in funding through the SAFE, the maximum number of shares that they can receive when the SAFE converts is 500,000 (the amount they invested divided by the cap). This means that even if the company’s valuation increases significantly after the SAFE is issued, the investors’ equity stake will be limited to no more than 500,000 shares.
Whether or not a SAFE has a cap will depend on the terms of the specific SAFE and the preferences of the company and the investors. Some SAFEs may include a cap to protect the interests of the investors, while others may not have a cap in order to provide more flexibility for the company.
The tax treatment of SAFE (Simple Agreement for Future Equity) notes will depend on a number of factors, including the specific terms of the SAFE, the tax laws of the jurisdiction in which the SAFE is issued and the investors are located, and the tax treatment of the equity that the SAFE converts into.
In general, the proceeds from the sale of a SAFE will be taxed as income for the company that issued the SAFE. The company will be responsible for paying taxes on the income it receives from the sale of the SAFE, and will need to report this income on its tax return.
For the investors who provide funding through the SAFE, the tax treatment will depend on the specific terms of the SAFE and the tax laws of the jurisdiction in which the SAFE is issued and the investors are located. In some cases, the investment may be treated as a loan and the investors may be able to claim interest payments as a tax deduction. In other cases, the investment may be treated as equity and the investors may need to pay taxes on any gains they realize when the SAFE converts into equity.
It’s important to note that the tax treatment of SAFEs can vary and it is essential to consult with a qualified tax advisor to understand the potential tax implications of investing in or issuing a SAFE.
If a startup that has issued SAFE (Simple Agreement for Future Equity) notes fails, the investors who provided funding through the SAFE will typically lose the money they invested. SAFE notes are unsecured investments, which means that they are not backed by any assets of the company and the investors do not have any claim on the company’s assets if the company fails.
In some cases, the terms of the SAFE may include provisions for the repayment of some or all of the investment if the company fails. However, this is not common and most SAFEs do not include such provisions.
If the company fails, the investors who provided funding through the SAFE will typically have to write off their investment as a loss. This means that they will not be able to recoup the money they invested, and will need to consider the investment as a loss for tax purposes.
