A Simple Agreement for Future Equity (SAFE) is a contract between an investor and a company that provides the investor with the right to receive future equity in the company under certain conditions. A SAFE is similar to a convertible note, but with a few key differences. Unlike a convertible note, a SAFE does not (1) accrue interest, (2) have a maturity date, (3) require a minimum amount of financing before it converts, or (4) have any debt-like features that would otherwise make it ineligible for qualified small business stock (QSBS) tax treatment.
In 2013, Y Combinator introduced the original SAFE as a simpler alternative to convertible notes. This six-page, one-document convertible instrument is known as the “pre-money” SAFE because it calculates the valuation cap on a pre-money basis.
In 2018, Y Combinator released an updated version called the “post-money” SAFE. The key difference between the two forms lies in how they handle dilution on the cap table.
Y Combinator has released four official SAFE types, each is explained in greater detail below. Note: A version is 'official' if it was published by Y Combinator and released on its website. As of September 2021, YC pulled down the post-money SAFE that features both a valuation cap and discount from its website. There are only three versions available for download, including: (1) valuation cap only, (2) discount only, or (3) most favored nation (as referenced below). The language in the SAFE allows for variation of the SAFE but requires drafters to remove the disclaimer if there have been any modifications to it.
Pre-money SAFE Types (These forms have been decommissioned at Y Combinator, but are available for download on Cooley Go):
Post-money SAFE Types (Available for download at https://www.ycombinator.com/documents):
| SAFE Term | Pre-Money SAFE | Post-Money SAFE |
| Company Capitalization | Includes all outstanding shares of capital stock, outstanding options, promised options, and the option pool increase, but not any converting securities | Includes all outstanding shares of capital stock, outstanding options, promised options, convertible securities, but not the option pool increase |
| Liquidation priority | Not included | Junior to outstanding indebtedness; on par with other SAFEs and Preferred Stock; senior to Common Stock |
| Choice of consideration in connection with liquidity event | Not included | Investor given a choice as to the form and amount if other investors are given a choice |
| Direct listing | Not listed as a liquidity event | Listed as a liquidity event |
| Ability to amend SAFE to include terms of subsequently issued SAFEs or convertible notes (MFN SAFE only) | Investor can amend SAFE if subsequent convertible notes or SAFEs are issued | Investor can amend safe if subsequent convertible notes or SAFEs with more favorable terms are issued |
| Must notify company if electing to amend SAFE to include new terms (MFN SAFE only) | Silent on period of time investor has to notify company | Must give company 10-day notice |
| Amendment of SAFE | SAFE can be amended by Company and Investor only | SAFE can be amended by company and investor or the holders of a majority of the outstanding SAFEs on the same terms |
| Assignment of rights in SAFE | Silent on assignent to an estate, heir, etc. upon the death or disability of the investor | SAFE can be assigned to an estate, heirs, executors, administrators, guardians and/or successors upon death or disability of the investor |
| Pro rata rights | Offered by default to every investor in the form of a side letter | No pro rata rights unless specifically negotiated in a side letter |
| Qualified Small Business Stock Treatment (QSBS) | Silent | Section 1202 of the Internal Revenue Code, which addresses QSBS, is referenced along with certain voting rights for taxes, dividends, etc. that the Safe will be upheld as QSBS by the IRS at the time of issuance versus at conversion of the SAFE. |
In addition to the different SAFE types, Y Combinator (YC) has also released updated versions of the post-money SAFEs. Below is an overview of the key differences between SAFE versions.
| SAFE Type | Version 1.0 | Version 1.1 | Version 1.2 |
| Post-money discount |
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| Post-money valuation cap and discount |
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| Post-money MFN |
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Post-money SAFEs can be perceived as less favorable compared to pre-money SAFEs because they often result in more dilution for founders because the SAFE holders are not diluted by any outstanding SAFEs or other convertible instruments when the SAFEs convert. In comparison with a pre-money SAFE, the SAFE holders are diluted by any outstanding SAFEs or other convertible instruments. While the pre-money SAFEs often result in less dilution for the founders, they also contain some unfavorable default provisions, such as providing all SAFE holders with pro rata rights in future rounds and allocating any dilution to the option pool increase to the founders.
Industry experts have suggested modifications to the post-money SAFE to address these concerns, such as only allowing the SAFEs issued at the same time and with the same valuation cap to be included in the company capitalization. including all converting securities outstanding as of the final closing of the SAFE financing in which the post-money SAFE is issued, but expressly excluding subsequently issued converting securities with different valuation caps.This modification to the post-money SAFE would help balance the dilutive impact on founders and investors.
In recent years, post-money SAFEs have become the preferred choice of SAFE by investors. In addition to providing the certainty of ownership and the anti-dilutive mechanism that post-money SAFEs provide, the post-money SAFE also has features that the original pre-money SAFE lacks, such as addressing QSBS tax benefits and clarifying exit scenarios. Many investors prefer post-money SAFEs over equity rounds due to their speed, lower cost and simplicity. However, some investors (particularly lead investors) still value the certainty of stockholder rights, board control and information rights provided by equity, as established in the standard NVCA legal forms.
Some investors try to combine the advantages of both worlds by using side letters attached to post-money SAFEs. These side letters include the essential investor rights such as information rights, pro rata rights and most favored nation provisions, providing a more balanced approach for both founders and investors.
Typically, a SAFE will convert into shares of preferred stock at the earliest of: (i) a financing round or (ii) a liquidity event. Because SAFEs are not issued at a fixed price and are only a promise for future equity, issuing additional SAFEs does not trigger the conversion of any outstanding SAFEs. In the same respect, the issuance of convertible notes or debt does not trigger the conversion of the SAFEs.
When the SAFEs convert into shares of preferred stock, they typically convert into shares of a separate sub-series of preferred stock called a “shadow series”. For example, if the next financing round is the Series A, the company may issue shares of Series A-1 preferred stock to the new money investors and shares of Series A-2 preferred stock to the SAFE investors.
A new shadow series is necessary because the SAFE investors are buying the same shares at a different price, so all mechanics that relate to the purchase price must be adjusted. Shadow series otherwise have identical rights, privileges, and preferences as the shares of preferred stock granted to new money investors.
Shadow series can get unwieldy, and it is not uncommon to see 3-4 shadow series, reflecting SAFEs with different valuation caps and discounts, on a company’s cap table.
The discount reduces the price per share used to calculate how many shares of the company’s equity the SAFE converts. The discount is typically a percentage and is determined at the time the SAFE is issued. It incentivizes investors to take the risk of investing in the company at an early stage by allowing them to receive more shares than the new investors when the SAFE converts.
Suppose that an investor makes a $500,000 SAFE investment and the SAFE includes a 20% discount. At the next financing round if the price per share is $1.00, the investors will have their shares converted at a price per share of $0.80. The discount allows them to receive 125,000 additional shares for their $500,000 investment because of the 20% discount.
Example:
$500,000 / $1.00 = 500,000 shares
$500,000 / $0.8 = 625,000 shares
If you are using the Y Combinator (YC) form of SAFE, you should be aware that the way the discount is presented is as a discount rate not as the discount itself. The discount rate is calculated by using 100 minus the percentage of discount. For example, if the discount is 20%, the discount rate is 100 - 20% = 80%.
However, because discount is the more commonly used term, investors will sometimes list the discount when the YC SAFE calls for the discount rate. In the above example, this would result in an investor receiving an 80% discount instead of the intended 20% discount.
If you are using a YC SAFE with a discount, it is important to check the discount rate to ensure that it reflects the intended discount. If the discount rate is less than 50%, it may be the case that it is incorrectly stated as most discounts are between 10% - 30%.
Founders use discounts to incentivize investors to fund the company at an early stage. The larger the discount, the more shares the investor will receive for their investment once the SAFE converts. Whenever a company issues additional shares, the existing stockholders are diluted because there are more shares outstanding. Therefore, founders do not want to issue SAFEs with significant discounts because they will be diluted when the SAFE converts. In most cases, the discount is between 10% - 30%.
Investors are willing to take risks in investing in a company, but they want to be rewarded for it. The earlier the investment, the higher of a discount that the investors will ask for to support their “risky” investment. They usually negotiate for a discount of 10% - 30%.
A valuation cap is the predetermined maximum valuation of a company that is used to calculate the amount of equity an investor will receive upon conversion. It “caps” the valuation of the company for purposes of the SAFE conversion. The valuation cap is typically set at the time of the SAFE investment and protects the investor from overpaying for the company's equity.
In a SAFE with a valuation cap, the SAFE converts using the following formula:
Valuation Cap / Company Capitalization = Conversion Price
As an example:
$15,000,000 / 10,000,000 shares = $1.50 per share
$25,000,000 / 10,000,000 = $2.50 per share
The valuation cap is not the same a valuation of the company. It is a negotiated number between the company and the investors and allows the company to postpone deciding on a valuation until a later date (i.e., at the next financing round or liquidity event). SAFEs are often used pre-product and/or pre-revenue when it is difficult to attach a valuation to the company. As a result, the valuation cap protects investors if the company's value increases significantly between the time the investment is made and the next financing round.
Valuation caps are a way for founders to raise money for their company without setting a formal valuation. The cap will give investors a discount when the safe converts, so founders try to set a cap that is close to the valuation they plan to use in the next financing round so they don’t take on too much dilution.
Valuation caps are a way for investors to get equity in a company at a discounted price. The lower the valuation cap, the better the deal for the investor. Typically, the earlier the company, the lower the valuation cap to compensate the investors for taking on more risk.
The most-favored nations clause allows an investor to get the same terms as any other investor if the terms are more favorable. This means that if a company offers a better deal to another investor, the investor can request the same deal, giving them the chance to get a better deal than they originally had.
YC offers two types of SAFEs (Simple Agreement for Future Equity): pre-money and post-money. The company capitalization is an important factor in the SAFE and is calculated differently for each type. This calculation ultimately determines the conversion price and which types of securities will dilute the SAFE holder when the SAFE converts.
Converting Securities
The company capitalization calculation in the pre-money SAFE does not include the SAFE, any other outstanding SAFEs, or convertible notes. This means these items are not taken into account when the SAFE convert. As a result, the SAFE holders will dilute one another when they convert. This is the more company friendly calculation.
In contrast, the company capitalization in the post-money SAFEs does include the SAFE, any other outstanding SAFEs, or convertible notes. This means the SAFE holders will not dilute each other when they convert. This is the more investor friendly calculation and the preferred calculation by investors because they are not diluted if the company issues additional SAFEs before their SAFE converts.
Option Pool
In the pre-money SAFEs, the company capitalization does include any option pool increase that takes place in the financing round in which the SAFEs converts. This means the SAFE holders are not diluted by the option pool increase.
In contrast, in the post-money SAFEs the company capitalization does not include any increase to the option pool unless the promised options are greater than the unissued option pool prior to such increase. This means the SAFE holders are diluted by any option pool increase. This is because the option pool increase is for employees hired after the SAFEs convert, so it is fair for all stockholders to experience dilution.
The table below outlines the differences between the pre-money SAFEs and the post-money SAFEs.
| Capitalization Term | Pre-money SAFE | Post-money SAFE |
| Capital Stock Issued and Outstanding | Included | Included |
| Converting SAFEs and Notes | Not included | Included |
| Issued and Outstanding Options | Included | Included |
| Promised Options | Not specified | Included |
| Unissued Option Pool | Included | Included |
| Option Pool Increase | Included | Not included unless promised options greater than unissued option pool |
If there is a liquidity event, the liquidation priority outlines the order in which any proceeds will be distributed. SAFE holders will be paid after debt and convertible notes, but before common stockholders. If there is any preferred stock outstanding, the SAFE holders will be paid on par with the preferred stock. If there is not enough money to pay the full investment amount of the SAFE holders, they will be paid in cash pro rata in proportion to their investment amounts and will receive shares of common stock equal to any remaining unpaid investment amount.
Pro rata rights give investors the right, but not the obligation, to purchase a proportionate amount of any new securities issued by the company. This proportionate amount is based on their existing ownership percentage in the company. The purpose of pro rata rights is to ensure that existing stockholders have the opportunity to maintain their ownership percentage in the company as the company grows. This helps ensure that their returns are maximized as the company continues to grow and do well.
In the pre-money SAFEs, the pro rata rights are included in the SAFE, but in post-money SAFEs are optional and included in a side letter. This side letter will calculate the investor's pro rata share by dividing the shares issued in the round by the company capitalization. If you are using a SAFE without a valuation cap (i.e., a discount only or MFN SAFE) please note you will need to make changes to the way that the pro rata right is calculated in the side letter as those SAFEs do not contain a company capitalization definition.
The side letter also clarifies that the pro rata right only applies to the next financing round whereas the pro rata right in the pre-money SAFE applies to the financing round after the equity financing round in which the SAFE converts. For example, if the SAFE converts in the Series A round, the pro rata rights apply to the next financing round, presumably the Series B round.
In recent years, YC SAFEs have been used to raise large amounts of capital, similar to a traditional financing round. In a traditional financing round, pro rata rights are only given to a subset of investors known as the major investors. By making pro rata rights optional, post-money SAFEs allow companies to grant pro rata rights to a subset of investors as well. Typically, companies will grant pro rata rights to their earliest investors or those that invest above a certain threshold. This helps the company control who can invest in future financing rounds and encourages investors to invest more in the company.
Founders want to limit the number of investors that have pro rata rights to incentivize investors to invest more capital into the company and to retain control over who gets to invest in future financing rounds. This means that founders typically only offer pro rata rights to their earliest investors or those who invest above a certain dollar threshold. Founders may also determine how much of the future financing round they want to allocate to pro rata rights and offer pro rata rights accordingly.
Pro-rata rights are the most important right for investors as it allows them to maximize their returns in successful companies. While all investors benefit from having pro rata rights, most investors understand that the company can not offer pro rata rights to all its investors. As a result, some investors will invest more money into the company to ensure they get pro rata rights. If they do not invest enough money to get pro rata rights, they may still be able to participate in subsequent financing rounds at the company’s discretion.