Mar 6, 2018, 11:58 AM ETConference Presentation, Webinar, Fireside Chat

Carolynn Levy and Kirsty Nathoo - Startup Investor School Day 1

Definition and Purpose: The SAFE (Simple Agreement for Future Equity) is a convertible security designed for very early-stage startups that have not yet issued priced rounds or preferred stock.
Non-Debt Instrument: A SAFE is not debt, does not accrue interest, has no maturity date, and carries no right to repayment; investors are explicitly advised against calling it a "SAFE Note."
Documentation Efficiency: The standard SAFE is a five-page document with only two key negotiable terms: the investment amount and the valuation cap, contrasting with the multiple lengthy documents required for priced rounds.
Missing Rights: The SAFE does not contain voting rights, information rights, or liquidation preferences, as these rights are inherited by the investor's stock once the SAFE converts to preferred stock.
Pro Rata Rights: The SAFE explicitly grants the investor the right to participate in future funding rounds (starting with the round after conversion) to maintain their percentage ownership, though it does not always specify this for the immediate conversion round.

Capped SAFE: The most common version, featuring a "valuation cap" that sets the maximum valuation at which the investment converts, rewarding early investors if the company's value grows significantly.
Discount SAFE: Uses a negotiated discount rate (typically 10–20%) applied to the share price of the future round rather than a valuation cap.
Uncapped SAFE: Contains neither a cap nor a discount, converting at the exact same price as the new investors; this is rare and usually indicates high demand for the company.
Most Favored Nation (MFN) SAFE: Lacks a valuation cap but includes a clause allowing the investor to adopt better terms (cap or discount) negotiated by subsequent investors in the same financing round.

Conversion Triggers: SAFEs convert during an equity financing (priced round), though the specific name of the round (e.g., Series A, Series Seed) does not affect the conversion mechanism.
Pre-Money Conversion: In standard practice, SAFEs convert before new money is added, meaning SAFE shares are included in the capitalization used to calculate the price per share for new investors, often reducing their ownership percentage.
Option Pool Impact: Before conversion, the company typically increases the employee option pool (commonly to 10% of post-money shares), which dilutes the SAFE investor's effective ownership percentage.
Mathematical Outcome: The number of shares received is calculated by dividing the investment amount by the conversion price, where the conversion price is the lower of the SAFE's valuation cap or the round's valuation, divided by the expanded capitalization.
Ownership Uncertainty: At the time of signing, investors cannot know their exact ownership percentage because it depends on future variables, specifically the size of the option pool and the amount of new money raised in the priced round.
Modeling Tools: Investors are encouraged to use tools like "AngelCalc" or custom spreadsheets to model scenarios, as conversion calculations can become complex with multiple SAFEs and varying caps.

Acquisition (Home Run): In a successful acquisition, the SAFE converts to common stock based on the valuation cap, allowing the investor to participate in proceeds alongside founders and other common shareholders.
Acqui-hire: In a low-value acquisition where assets are not sold, the SAFE holder has the option to either convert to common stock or have the SAFE paid off (usually at a return lower than the original investment).
Dissolution: In a failed company, SAFE holders are paid after trade debt and employee salaries but before common stockholders; however, recovery is often minimal or non-existent in practice.
Lifestyle Companies: If a company becomes self-sustaining without a priced round or acquisition, the SAFE does not address the situation, requiring negotiation between founders and investors to resolve ownership or repayment.

Handshake Protocol: Y Combinator recommends a written email exchange confirming terms (amount and cap) to finalize a "handshake deal" before sending formal documents, preventing misunderstandings regarding investment intent.
Signature Platforms: Most YC founders use Clerky for e-signing standard SAFE templates, though other platforms like HelloSign or DocuSign are acceptable; investors must verify legal entity names if investing via trusts or LLCs.
Speed and Diligence: Founders expect investors to wire funds immediately after signing; conversely, investors should demand detailed conversion calculations and pro forma cap tables before signing the conversion documents in a priced round.
Enforcing Rights: Investors are advised to review conversion documents for compliance with their SAFE terms (specifically pro rata rights) and immediately push back if rights are ignored, as this is a contractual breach.
Entity Structure: Investing directly or through a trust is standard for individuals, while LLCs or funds are recommended for pooling money from multiple investors.
Legal Requirements: A SAFE does not require a Private Placement Memorandum (PPM) or a term sheet; a single standard agreement is sufficient.

Upside Focus: Investors focused on power-law returns should not waste time negotiating downside protection; the goal is securing high upside potential rather than mitigating small losses.
Founder Relationship: Angels should provide help only when requested and avoid joining the board unless necessary; supporting the founders through pivots is critical because the SAFE is not debt.
International Applicability: SAFEs work globally in most jurisdictions (e.g., UK adaptations for tax relief), but some countries (e.g., India) may have restrictions depending on investor eligibility.
Transparency: Investors should proactively ask founders for transparency regarding rights and capitalization changes, leveraging their status as the first believers to ensure fair treatment.
Structural Evolution: While the original SAFE was drafted assuming pre-money conversion in 2013, market trends now heavily favor pre-money conversion, and the YC team is considering updates to address evolving seed round dynamics.
MFN Limitations: The standard MFN clause applies only to uncapped SAFEs; it is not standard practice to negotiate an MFN on a capped SAFE, as the initial bargain is considered final.