A SAFE is a financing instrument which some early stage companies use to secure funding without issuing actual shares in the company at that time. Instead, the SAFE agreement provides the right for an investor to purchase equity at a later date, during a formal priced equity round. SAFE stands for “Simple Agreement for Future Equity.” SAFE agreements don’t pay interest or a dividend, but they do often involve a minimum investment, a valuation cap (or not), a discount off the conversion price when a formal equity round happens (or not), and can include a “most favored nations (MFN) clause.” An MFN clause allows the holder to inherit any more favorable terms that are provided to any other investors after the original investor’s investment but prior to the next equity round.

The first SAFE agreement was created by Y Combinator lawyer Carolynn Levy to allow for the company to take on funds without incurring debt; some companies use the SAFE instead of issuing convertible notes. A SAFE agreement is not a debt instrument and does not carry any interest benefit for the holder.

Early stage companies like SAFE notes for their ease of use and relatively lower cost to implement. Compared to convertible notes, for example, they simplify negotiations and avoid extensive legal fees. In addition, SAFE notes eliminate the need to renegotiate maturity dates in the event the company takes longer to attain its needed cash flow position to pay interest or repay invested capital from convertible notes.

However, entrepreneurs who use SAFE notes should be careful to fully understand the dilution to equity that they bring. Unfortunately, entrepreneurs who are not aware of the dilution at the time the SAFE notes are issued will have quite a reckoning when the first priced equity round occurs. One suggestion is to prepare a fully diluted-post money cap table for your expected first equity raise before accepting any pre-round SAFE investment. Have a clear picture of what your ownership structure will be once the priced round occurs, so you are comfortable with the resulting dilution to your ownership. If you would not be, then you may want to reconsider equity and instead develop a mechanism to fund your growth through debt.

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