Introduction to SAFE Agreements
The SAFE Agreement stands for “Simple Agreement for Future Equity”. The SAFE was pioneered by Y Combinator, a technology startup accelerator. When it was first introduced in 2013, the SAFE was a pre-money valuation cap, but in 2018 redrafted the SAFE to a post-money valuation cap focus. The SAFE has become popular as a convertible security instrument for startups to raise funds, and it is attracting attention from startups in this region (South East Asia) as well.
Essentially , SAFE Agreements are simplified agreements for a seed round investor to invest into a startup, while securing its expectation to receive shares when the startup reaches the Series A funding round. How much shares a seed round investor will receive under the SAFE post-money valuation cap model, is determined by the valuation cap, and the discount rate (if applicable).
What is a seed round
Seed round investors are early stage investors into a startup. Y Combinator describes it as follows:
The initial capital raised by a company is typically called “seed” capital.Y Combinator, “A Guide to Seed Fundraising“
Four varieties of the SAFE Agreement
There are four variants of the SAFE agreement which have been made available at the Y Combinator website. All four of them are focused on post-money valuation cap.
- MFN (Most Favoured Nation), without Discount and Without Valuation Cap;
- Discount only;
- Valuation Cap only;
- Both Discount and Valuation Cap.
Pro Rata Side Letter
There is also a pro rata side letter, which acts as a supplementary agreement. Essentially, it gives the investor a right to participate in the Series A funding round. For some investors, it may be important for them to “top up” their shares in the startup if they believe that the startup will do well.
An MFN SAFE does not usually require the pro rata side letter, according to the Post-Money SAFE user guide.
Valuation Cap and Discount Rate
The valuation cap is agreed upon by the parties, as to what the maximum valuation of the startup could be, at a later date. It is not meant to be a valuation at the present date. An investor that invests with a lower valuation cap, will get more shares when the startup goes for its Series A.
The Discount Rate in the SAFE Agreement is the percentage that an investor pays, compared to the full price of the stock. The difference of a “discount rate” from a “discount” is this: Discount rate is a percentage of the price (that is payable), rather than a percentage off the price (that is rebated from payment).
Events in the SAFE
Under a SAFE, there are several events, which trigger the contract to the next stage.
- A “Liquidity Event”, in which a Series A investor invests into the startup;
- A “Dissolution Event”, which the startup is wound up.
When one of these events occur, the seed round investor is allocated shares in the startup. In the Liquidity Event, the seed round investor’s shares, together with the startup founders’ shares, will then be diluted, by the investment of the Series A investor.
Adapting the SAFE to Malaysian Usage
There is a variant of the SAFE Agreement on the Y Combinator website that is customized for the jurisdiction of Singapore. The Singaporean laws and Malaysian laws are quite compatible and it is possible to customize the Singaporean version of the SAFE for Malaysian startups.
There are a number of Malaysian founders who choose to incorporate their startup in Singapore for purposes of fundraising. Perhaps for strategic reasons, this could add to the allure and confidence that future investors have in the startup. In such cases, using the Singaporean version of the SAFE may be sufficient. The version available as of the date of writing this article (August 2022) is for valuation cap, with no discount.
What terms are reasonable – valuation cap and discount?
Many startups have used the SAFE for seed round funding. Ultimately the valuation cap and discount will depend on your discussion with the seed investor(s). From a brief review of documents lodged with the US SEC, you can see that startups range widely in their SAFE valuation caps and discounts.
1. Newchip Inc, $15 mil val. cap, 75% discount rate – link
2. Technocentra Group Inc, $7 mil val. cap, 80% discount rate – link
3. Rentberry Inc, $7 mil val cap, 30% discount rate – link
4. SOS Hydration Inc, $14 mil val cap, 100-50% discount rate, provided if $1 mil is raised within certain parameters, etc. the discount rate is 100-25% – link
5. Inspira Technologies Oxy BHN Ltd, $70 mil val cap, 30% discount rate with 24 months maturity date – link
Ultimately you need to understand that the lower the valuation cap, the more shares your seed round investor gets. Thus, with Inspira’s $70 million valuation cap, a 30% discount rate was negotiated.
Thank you for reading.
This article was prepared for informational purposes only. Please consult with a lawyer before making any decision.