The SAFE: A Simpler Way to Invest in Startups

Thomas | Posted on 15/02/2024 |

The journey of a startup is fueled by innovation, but also by access to capital. In this fast-paced landscape, a financing mechanism gaining popularity is the SAFE. Here’s a breakdown of SAFEs, why they’re appealing, and the nuances to be aware of.

What is a SAFE?

A SAFE stands for Simple Agreement for Future Equity. It is an agreement where an investor gives money to a startup in exchange for the right to obtain shares in the company at a later date, usually during a future funding round or acquisition. It eliminates the complexities of valuing an early-stage company or setting interest rates, simplifying the investment process.

Why Use SAFEs?

Speed & Simplicity: SAFEs are more streamlined than traditional investment agreements, making them attractive for early-stage companies where time is of the essence.
Valuation Flexibility: Companies and investors don’t get stuck negotiating exact valuations in a startup’s unpredictable early days.
Founder-Friendly: SAFEs often lack heavy contractual terms or repayment obligations that can weigh on young companies.

The Rise of SAFEs

SAFs originated with Y Combinator, a renowned startup accelerator in Silicon Valley. Their user-friendly structure propelled their popularity beyond the US and into Europe. More and more investors and startups find SAFEs a suitable model for early-stage deals. On the YC website you can still find SAFE documents and templates.

A Dutch BV Example

Let’s imagine a Dutch BV (a private limited company) called InnoTech BV. An investor agrees to provide InnoTech BV with €100,000 via a SAFE agreement. Here’s a simplified view of how it might work:

Triggering Event: InnoTech BV secures its next funding round at a €2 million valuation.
Discount: The SAFE might include a 20% discount, granting the investor the right to buy shares at €1.6 million rather than the new valuation.
Conversion: The investor’s €100,000 investment converts into shares, giving them a stake in InnoTech BV.

Types of SAFEs

Let’s break down the most common SAFE structures:

Scenario 1: Valuation Cap, No Discount

How it works: Investors get future shares at a predetermined price based on a valuation cap, protecting them if your company’s valuation skyrockets.
Example: Your SME secures a €50,000 SAFE investment with a €5 million valuation cap. If your next funding round establishes a €10 million valuation, the SAFE investor’s shares would be priced as if the valuation was only €5 million.

Scenario 2: Discount, No Valuation Cap

How it works: Investors receive a discount on future shares regardless of your company’s valuation, offering a reward for taking on early-stage risk.
Example: You offer a 20% discount on a SAFE investment. During a future funding round, regardless of the company’s valuation, the SAFE investor purchases shares at a 20% discount.

Scenario 3: Valuation Cap and Discount

How it Works: Investors enjoy both a valuation cap and a discount, providing maximum flexibility.
Example: A SAFE with a €5 million valuation cap and a 20% discount allows the investor to choose the most beneficial scenario during a future funding round.

Scenario 4: Most Favored Nation (MFN)

How it works: This clause ensures an early SAFE investor receives the same advantageous terms as subsequent SAFE investors if better terms are offered in the future.

Scenario 5: Fixed Conversion at a Future Date

How it works: The SAFE will convert into equity at a specific future financing event (e.g., a Series A round) at a predetermined share price or valuation.

SAFE Investment Example: Choosing the Best Option

Imagine your SME secures a €50,000 SAFE with a €5 million valuation cap and a 20% discount. Your next funding round has a €10 million pre-money valuation. Let’s analyze the investor’s options:

Option 1: Discount
- Share Price: €5 (seed round price) * (1 – 20% discount) = €4
- Shares Received: €50,000 investment / €4 share price = 12,500 shares
Option 2: Valuation Cap
- Share Price: €5 (seed round price) * (€5 million cap / €10 million valuation) = €2.50
- Shares Received: €50,000 investment / €2.50 share price = 20,000 shares

In this scenario, the investor would likely choose the valuation cap since it yields a higher number of shares.

Key Parts of a SAFE Agreement

While SAFEs are designed for simplicity, here are key elements to include:

Investment Amount: The sum being invested.
Valuation Cap (Optional): A ceiling on the valuation used for conversion, protecting the investor if the company valuation skyrockets.
Discount Rate (Optional): A percentage discount on future shares in exchange for early investment risk.
Triggering Events: Milestones (new financing, sale of the company) that convert the SAFE into shares.

SAFE vs. Convertible Loan

Convertible Loan: Technically debt converting to equity under certain conditions. Often includes interest rates and maturity dates.
SAFE: Not debt, less burdensome for early-stage startups. No interest or fixed repayment timelines.

SAFs often suit very early rounds when valuation is most uncertain. Convertible loans might be chosen when companies are slightly further along, or where investors desire an interest element.

You can create a convertible loan agreement and read more about the CLA on this page.

Tax Considerations for SAFEs

Tax treatment of SAFEs, and potential alternatives vary across European countries. Factors like classification as debt or equity significantly impact the tax picture. Here’s a brief overview:

Netherlands: Treatment can be ambiguous. If treated as debt before conversion, there may be complications involving interest deductibility. Tax advisers in the Netherlands who can help you can be found here.
Norway: SAFEs could be treated as debt (creating immediate tax implications) or as equity (deferring taxation). Norway’s SLIP (“Startup’s Lead Investment Paper”) is a SAFE-like instrument aiming for clearer equity classification. A tax professional, however, is always advisable.
Finland: SAFEs lean towards equity treatment upon investment. Conversion can still trigger capital gains tax and may negate benefits compared to traditional loan structures. More in our guide on Finland.
Sweden: SAFE tax status has some uncertainty in Sweden. Possible to defer taxation until share sale, but debt classification gets complex at later stages.
Denmark: Generally, SAFEs may be seen as equity. Capital gains tax on investment disposal could be more favorable versus income tax (like on debt). Potential loss deductions might become unavailable in Denmark.

There’s no one-size-fits-all approach for the tax treatment of SAFEs in northern Europe. Specific case details and expert tax advice within each country are crucial for proper decision-making and compliance. Get in touch with a tax adviser to learn more.

Pros and Cons of SAFEs

Pros

Investors: Potential for significant return on early-stage investment.
Startups: Quick, streamlined funding without cumbersome debt obligations.

Cons

Investors: Less protection than convertible notes; conversion depends on later events.
Startups: Dilution of ownership when SAFEs convert.

SAFs offer an adaptable and rapid path to funding, potentially streamlining the crucial early phases of a startup. However, understanding the nuances and seeking expert guidance is essential for both startups and investors.