Fundamentals of a New and Popular Investment Model: Simple Agreement for Future Equity (SAFE) by YC

Introduction

Raising funds during the startup process is a very challenging phase for investors. However, thanks to the emergence of new financing models, entrepreneurs have the opportunity to choose from various financing options to realize their ventures. One of the most popular investment models today, among others, is SAFE by Y Combinator. The SAFE, or Simple Agreement for Future Equity, investment model is designed to streamline and simplify the investment process for early-stage startups. The model essentially represents a contractual agreement between an investor and a company, whereby the investor provides capital in exchange for the right to obtain equity in the company at a future financing round, or upon a specific liquidity event.

This memorandum touches upon the fundamentals of the SAFE and aims to help you to understand if it can be a good fit and advantageous for your business.

What is SAFE and How Does It Work?

The SAFE model allows startups to secure funding without an immediate valuation requirement upon investment. As a result of it, founders retain the option to delay the allocation of equity until a subsequent funding round or the event of a company sale, facilitating the establishment of a valuation and subsequent equitable distribution of shares to investors, as per the agreed terms.

Additionally, the SAFE by Y Combinator framework provides a degree of flexibility concerning investment terms and thanks to this flexibility, startups and investors can have the opportunity to engage in negotiations regarding various components of the agreement, encompassing valuation caps, discount rates, and conversion terms. Investors are also afforded the choice to convert their investment into equity during the subsequent funding round or at the maturity date stipulated in the SAFE.

Advantages

Among the many benefits of the SAFE investment model, some of the most important advantages can be summarized as follows:

1. Flexible: One of the most remarkable benefits of SAFE by Y Combinator is its flexibility which serves the interests of both investors and founders. Startups can secure funds without the immediate need for valuation determination, while investors can engage in negotiations for investment terms tailored to their specific requirements.

2. Fast and Simple: SAFE is a simple and straightforward agreement with fewer variables to understand and negotiate which allows startups to get that first money into the company without facing a long and complicated due diligence process.

3. Investment: The startup is funded by an investor in exchange for the right to obtain equity in the company at a future financing round or specific event, such as a merger, acquisition or initial public offering (IPO).

4. No Interest or Maturity Date: There is no interest or maturity date within the SAFE, therefore, there is no necessity to allocate money or time towards extending maturity dates, revising interest rates, or similar actions. Thanks to SAFE, founders of a startup do not have to spend time on keeping track of interest or asking investors for extensions when maturity dates come closer which enables founders to better focus on growing their startup. It is worth noting, however, that in certain cases, an investor may seek to include a "Maturity Date" clause. This provision becomes relevant in instances where startups do not require further financing and the investor's path to acquiring equities is contingent upon a need for funding.

5. Lower Costs: The streamlined structure and simplified approach to fundraising make the SAFE investment model often perceived as a cost-efficient option. It tends to minimize legal and administrative expenses compared to traditional equity or debt financing, thus attracting both startups and investors. It also saves associated costs in relation to the transaction.

Disadvantages and Risks

Despite the various advantages offered by the SAFE investment model for both early-stage startups and investors, it entails certain risks and drawbacks, including:

1. Dilution Risk: When a startup raises additional capital at a higher valuation in subsequent financing rounds, new shares are typically issued to incoming investors. This issuance of new shares can lead to a dilution of the ownership stakes of existing shareholders, including those who initially invested through SAFE agreements. Nevertheless, it has become an industry standard in recent times for investors to safeguard their interests by incorporating "anti-dilution" clauses into the SAFE. As a result, the risk of dilution is shifted onto the founders, necessitating their careful consideration of potential future dilutions.

2. Uncertain Future Valuation: There is a risk of uncertain future valuation of the equity that the investor will receive upon conversion of the SAFE into equity in the future as the valuation of the company is not determined at the time when the SAFE agreement is executed. This future valuation which is uncertain by nature of SAFE Investment model can lead to challenges and disputes during subsequent funding rounds or events triggering the conversion of the SAFE due to the fact that the actual worth of the company may be different from initial expectations.

3. Lack of Investment Control: Under the SAFE investment model, investors partaking in a SAFE agreement generally have less influence or authority in crucial decision-making processes, such as voting in board of directors' elections, major business transactions, or other critical corporate resolutions. This divergence from traditional equity investments may potentially diminish investors' impact on the company's direction and management, in spite of their financial investment and stake in the business.

4. Startup Failure Risk: Given the inherent risks in startups, there is the potential risk for the company to fail to achieve expected milestones or generate sufficient revenue, thus exposing the investor's capital to risk with limited means of recovery. In such a situation, investors committing funds through SAFE agreements may face challenges with regards to the risk of recovering their investments since there is an absence of a maturity date or repayment obligation as mentioned above.

5. Regulatory Compliance Challenges: Regulatory compliance can present challenges depending on from jurisdiction to jurisdiction, especially concerning securities regulations and laws safeguarding investor interests. That’s why ensuring that the terms of the SAFE agreement align with relevant securities laws is vital to mitigate potential legal consequences.

‘‘SAFT’’ in Cryptocurrency Investments

SAFT, which stands for "Simple Agreement for Future Tokens", operates similarly to the Simple Agreement for Future Equity (SAFE) utilized in traditional startup funding with one major difference: the agreement is for tokens rather than equity (i.e. company stock). The SAFT framework enables companies to generate capital by offering rights to forthcoming tokens, to be issued upon the operational functionality of the related platform or project, and upon the tokens attaining practical utility. In essence, investors procure SAFTs, embodying their entitlement to acquire tokens at a specified future date. The SAFT model was developed as an attempt to manage regulatory complexities, particularly in the US, regarding initial coin offerings (ICOs) and token sales.

Conclusion

In conclusion, the SAFE investment model provides startups and investors with a flexible, straightforward, and cost-effective approach to fundraising with lots of further advantages. Furthermore, the introduction of the SAFT framework in the cryptocurrency realm enables companies to raise capital by granting rights to future tokens. While it offers benefits such as streamlined transactions and reduced costs, it also comes with inherent risks, including potential dilution, uncertainties in valuation, limited investor control, startup failure risks, and challenges in regulatory compliance. Thus, it is crucial for stakeholders to carefully assess the dynamics of the SAFE model and related adaptations to make informed decisions in navigating the complexities of startup financing and cryptocurrency investments.

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