A simple agreement for future equity (SAFE) is an agreement between an investor and a startup company that provides the investor with the right to receive equity in the company at a later date. The SAFE is similar to a convertible note, but does not accrue interest or have a maturity date.
The SAFE is designed to simplify the process of investing in a startup by eliminating the need to negotiate the terms of the investment (such as the price per share) upfront. This makes it easier and faster for startups to raise capital, which can be helpful in the early stages of the company's development when time is of the essence.
The key terms of a SAFE include the amount of money the investor will provide to the company, the valuation cap (the maximum valuation of the company at which the investor's equity will be calculated), and the discount rate (the percentage by which the investor's equity will be discounted from the company's valuation at the time of the equity issuance).
To illustrate how a SAFE works, let's say that an investor provides $100,000 to a startup in exchange for a SAFE with a valuation cap of $1 million and a 20% discount rate. If, at the time the SAFE is converted to equity, the company has a valuation of $1 million, the investor would receive 5% equity in the company (i.e., $100,000 divided by $1 million). However, if the company's valuation is $2 million at the time of conversion, the investor would only receive 2.5% equity in the company (i.e., $100,000 divided by $2 million, minus the 20% discount).
One potential downside of the SAFE is that it may create a "cliff" in the equity ownership of the company, where the SAFE investors own a large chunk of the company but the founders own very little. This can be problematic if the company is not successful and needs to be sold, as the SAFE investors may be reluctant to sell the company for less than the valuation cap, even if it is in the best interests of the company's stakeholders.
Another potential downside is that, depending on the terms of the SAFE, the investors may have to wait a long time to receive their equity. For example, if the SAFE has a "qualified financing" clause, the investors will only receive their equity once the company has raised a certain amount of money from other investors (usually venture capitalists). This can delay the return on investment for the SAFE investors and may lead them to seek other opportunities.
Overall, the SAFE is a helpful tool for startups to raise capital quickly and efficiently, but there are some potential drawbacks to be aware of.