SAFE agreement for capital raising
Simple Agreement for Future Equity (SAFE)
הסכמי (SAFE ( Simple Agreement for Future Equity
Investing agreements have become more and more common in recent years, and are agreements between investors and entrepreneurs during the early stages of startup development.
As a preferred option for entrepreneurs and start-up companies, these agreements are also attractive to investors – thus, they have become an increasingly popular investment arrangement since they were first introduced in 2013.
By Igal Mor, Adv. & Notary
Accuracy in Legal Advice. Excellence in legal support.
What is the SAFE Agreement?
In order to understand what the SAFE agreement is, it is important to understand the investment method in start-up companies. Typically, a startup company at the beginning of its journey will not be able to exist for a long period of time without raising initial capital, which will allow it to survive in the absence of profits during the development and establishment phases. Investing in startup companies is based on capital raising rounds, which vary according to the company’s situation. During each capital raising round, investors will receive shares for a set value, and each round will have a different objective. As early capital raising and investment rounds address needs such as product development, research, establishment of the company, and production mechanisms, advanced capital raising rounds aim to turn the venture into an independent, profitable, developed, and successful enterprise.
SAFE agreements are agreements between the investor and the entrepreneur, which are usually concluded in the earliest stages of the company’s capital raising. In accordance with the agreement, the investors make a financial investment in the company at an early stage, when the value of the company is unknown. Therefore, the investor does not know what his holding rate will be (the number of shares he will receive in exchange for his investment). As a general rule, the agreement will allow the investor to purchase shares of the company in the future at a discount, up to a certain maximum amount.
When is a SAFE agreement required?
Using the SAFE agreement is an effective solution when a company has an immediate financial need, but does not wish to engage in a real fundraising round which involves the issuance of shares. The SAFE agreement may therefore be useful even if the company is required to raise capital immediately between rounds of fundraising.
What are the benefits of the SAFE agreement?
SAFE agreements offer the main advantage of allowing both parties to draw up an investment agreement, even in cases where there is a disagreement between them concerning the current value of the company, without the necessity of lengthy and costly negotiations. Therefore, the entrepreneur and owner of the startup company can benefit greatly from raising funds through these agreements during the early stages of the company’s development, even without a clear valuation. The agreement provides the investor with the right to maintain his ownership interest in the company at a later date once its value is clear. Furthermore, the agreement usually stipulates provisions for the future sale of the shares at a discount, up to a specified ceiling amount; Therefore, the investor also benefits from this contract, as it allows him to guarantee his advantages over the other investors.
Types and Formulas
Drafting SAFE agreements are a real art if you can say that about drafting agreements. They include various conditions of the right to purchase shares in the future by the investor. Thus, the SAFE agreement can provide for a future purchase of the shares at a discount (for example, 10% or 20%). There may also be a clause in the agreement that specifies value protection for the investor (Cap) – a maximum price that the investor will be required to pay for the purchase of future shares. Value protection is intended for the case where the value of the company rises significantly.
The SAFE agreement will be structured according to one of four types:
- SAFE agreement which includes a discount and value protection;
- SAFE agreement which includes discount only;
- SAFE agreement which includes value protection only;
- SAFEMFN Agreement – This is an agreement that does not include any value protection or discount, and grants the right to purchase shares in the future under the terms of the next fundraising round.
What to watch out for?
As with any agreement, it is very important to read the SAFE agreement between the lines in detail, in order to avoid a situation of future deprivation. Thus, the SAFE agreement may have significant disadvantages for entrepreneurs who need immediate funding, since it grants extreme privileges to investors at the expense of entrepreneurs. Also, and even from the other direction, the SAFE agreement may harm the investors’ interests; For example, a SAFE agreement that does not provide value protection or any discount to investors, may disadvantage them in front of other investors in the next round of investment.
Several pointers
When it comes to the SAFE agreement, there are several key points to keep in mind (whether you are an entrepreneur or an investor).
One of the main concerns of the investor is that there will not be another round of investment and therefore he will not be able to exercise his rights. Therefore, it is highly recommended to include in the agreement a clause allowing the investor to purchase his shares at a predetermined price if such a situation arises. As mentioned, from the investor’s perspective, it is highly recommended to include in the agreement a clause that establishes a discount price and a ceiling price for the purchase of the shares.
A third option that may be advantageous to the parties is to include an option for Pro-Rata rights in the agreement. By exercising these rights, the investor is able to maintain his percentage of ownership in the company in the next fundraising round. Remember, in each round of capital raising, shares of the company are issued, thereby diluting the controlling power of existing investors. Providing investors with the option to preserve their shares strengthens strong investors who wish to make long-term investments in the company.
