To SAFE or not to SAFE? What you need to know about simple agreements for future equity

24th September 2022

As the venture capital ecosystem in Australia continues to evolve and grow, there is a desire to simplify what can be an overwhelming and complicated process – raising money. Too often agreements take weeks and cost hours of expensive legal and accounting advice. This process of negotiation and contract writing can be long and arduous. Luckily, there’s a solution: the Simple Agreement for Future Equity (SAFE). On the surface these might feel straightforward and ‘safe’ but what do investors and founders need to look out for when dealing with them? Quentin Wallace and Ben Armstrong from Archangel Ventures joined our latest VC Catalyst Alumni Masterclass to answer this exact question. Here’s what we learnt:

First, what is a SAFE?

SAFE (Simple Agreement for Future Equity) Notes were originally created by Y Combinator in the US and have recently risen in popularity in Australia, particularly amongst early-stage startups. SAFEs are relatively simple legal documents that postpone ownership in a startup until a later funding round. By design, SAFEs facilitate a more efficient process for initial funding rounds, giving back time to founders so they can concentrate on building their companies. 

They’re seen as more practical and straightforward than convertible notes. Although similar in concept, SAFEs do not accrue interest. Future equity is agreed to in the SAFE through a valuation cap and discount. This determines the price of shares in the later funding round and ensures SAFE investors aren’t ripped off when new investors enter the scene. See an example of how this works in practice here.

While in the USA, the original (and gold standard) Y Combinator SAFE remains consistent across all deals (it can’t be legally altered), SAFEs in Australia are less homogenous and often differ greatly from one another. The first localised SAFE was developed by the Australian Investment Council (AIC), however many versions of this document exist in the landscape. This can at times slow down the SAFE process here in Australia as additional due diligence is required. 

SAFEs can be ‘pre-money’ or ‘post-money’. For the purposes of this article, we’ll focus on ‘post-money’ SAFEs. Learn about the difference here. 

What to look out for

Although generally faster and less expensive than convertible notes and more involved deal contracts, SAFEs do have a few cons and a few things to watch for.

1. In Australia, SAFEs differ greatly from one another. Every time you engage with a SAFE, there’s a good chance you’ll be dealing with a different document. Don’t get caught out and do your homework.
2. SAFEs provide a simplified legal framework upfront, but when it’s time to convert SAFEs (i.e. in a price round, when the investor becomes a shareholder), things tend to heat up and get a lot more complex. This is a common time for tension, as the complexity of conversion maths can cause headaches for both investors and founders alike. Get a specialised accountant here.
3. SAFEs still involve risk as everybody involved is banking on a future (predicted) valuation of a company. It’s important for both founder and investor to appropriately weigh up the value cap to ensure optimal founder dilution and investor equity down the track.
4. Unlike in traditional price rounds, SAFEs can (and do) include different terms and value caps for different investors. Therefore investors can have less certainty on who else is investing and on what terms they are doing so.

Advantages of SAFEs

For early-stage deals, SAFEs are here to stay. While they have their drawbacks, they provide plenty of advantages for both founders and investors. 

1. SAFEs delay valuation which reduces an investor’s dilution. As they take on more risk earlier in the game, SAFEs ensure an investor benefits over new investors down the track once the startup is valued.
2. For founders, there is a benefit in having different terms with different investors. Although challenging to do in traditional funding rounds, this is commonplace for SAFEs.
3. SAFEs are transparent documents that spell out clearly how much dilution founders will take on and what equity investors will get once the pricing round is triggered. A big positive for investors is knowing exactly what percentage in the company they’ll get once the SAFE is converted.
4. SAFEs put money into a startup fast, giving early-stage businesses the foundation and support to get moving, hiring, testing, prototyping and making money. This in the end benefits both founder and investor.

Where to go for more

Hungry for more? Helpful resources for SAFEs more generally and specifically for Australia include: 

1. The article by Quentin Wallace over on the Archangel blog here has more information on SAFEs and their pros and cons.
2. The original Y Combinator documents are here and the comprehensive user guide are over here.
3. Help with calculating SAFE conversion here on Safe Genie (it gets tricky and complicated quickly).

All in all SAFEs provide a simple and cost-effective route to early-stage funding. And anything that supports the ideas of Australia’s next generation of startups and big ideas is a plus in our eyes. 

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This masterclass was just one of many VC Catalyst alumni learning opportunities. An essential component of the program is continuous learning and alumni connection. Following participation in the program, alumni cohorts meet regularly for sessions just like this one. Interested in VC Catalyst? Learn more or enquire now. 

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Disclaimer
The information in this article is for general information only. It should not be taken as constituting professional advice. You should always seek independent legal, financial, taxation or other advice to check how this article relates to your unique circumstances. No liability will be assumed for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this article.