Do SAFEs convert to preferred or common stock?
It is worth noting that SAFE notes convert into preferred stock, so depending on the liquidation preferences, SAFE note holders may be entitled to receive the proceeds of the sale before common stock holders of the company.
If there is an Equity Financing before the termination of this Safe, on the initial closing of such Equity Financing, this Safe will automatically convert into the number of shares of Standard Preferred Stock equal to the Purchase Amount divided by the Safe Price.
The SAFE defines three possible events which will trigger the conversion or termination of the SAFE investment: (a) an Equity Financing, (b) a Liquidity Event, and (c) a Dissolution Event. The SAFE converts and terminates on the first of these events to occur.
Conversion during financing: When your startup raises its next round of financing, SAFEs convert to equity. Your company will get a new valuation and your SAFE investors will receive shares based on the agreed-upon rates.
A safe holder gets the same preferred stock, at the same price, with the same liquidation preference, as the other investors of new money in the financing.
Convertible preferred stock offers the investor the benefits of both preferred stock and common stock. Investors get the stability, liquidation priority, and higher dividends of preferred stock, but they also have the option to convert their shares into common stock later if they believe that the price will go up.
If a SAFE note never converts, the investors who provided funding through the SAFE will not receive any equity in the company. The terms of the SAFE will typically specify what will happen in this situation, but in most cases the investors will simply lose the money they invested through the SAFE.
Now, the SAFE investment is converted to shares. Under the pre-money SAFE, the conversion price is calculated as follows: Conversion price = Pre-money valuation cap / company's capitalisation (or a total number of shares before the new investment round and excluding all SAFE investments to be converted).
SAFEs do not represent current equity stakes in the company, and so do not provide you with voting rights similar to common stock. But there may be particular circ*mstances mentioned in the SAFE that allow you a voice on matters pertaining to your SAFE.
SAFE notes are typically more founder-friendly, as they do not carry interest rate or have maturity date, making them less financially burdensome to founders compared to convertible notes.
Are SAFEs considered debt or equity?
No, a SAFE note is not a loan or debt, it is accounted for an equity on the balance sheet. Unlike convertible debt - or pretty much any debt, it does not have an interest rate nor does it have a maturity date.
Benefits for Investors
For investors, the primary attraction of a SAFE is the potential for high returns. If the startup succeeds, their equity could appreciate substantially. Since SAFEs are used primarily in early-stage startups, the initial investment is typically lower than in later funding rounds.
A Simple Agreement for Future Equity (SAFE) is a contractual agreement between a startup company and its investors. It exchanges the investor's investment for the right to preferred shares in the startup company when the company raises a future round of funding.
Once a company enters liquidation, the trading of its shares is halted. These shares will then be “deemed worthless”, a term given to shares in companies that no longer exist. Shareholders who own shares in such a company can declare them as a capital loss, which can result in paying less income tax.
This simplicity is where much of the benefit lies for founders and investors. What makes a SAFE “simple”? Unlike convertible notes, SAFEs do not have: Maturity dates.
Common stock investments have a potentially larger reward, but also come with more risk because they're exposed to the market. Preferred stock investments are a safer investment with fixed-income dividends, but investors may miss out on a share's appreciation they would get with common stock.
Conversion. Another difference between common shares and preferred shares is the ability to convert one type of stock to another. Investors can convert preferred stock into a definite number of ordinary shares. Investors holding common shares don't have the privilege of converting them into preferred shares.
What Are the Advantages of a Preferred Stock? A preferred stock is a class of stock that is granted certain rights that differ from common stock. Namely, preferred stock often possesses higher dividend payments, and a higher claim to assets in the event of liquidation.
In a Liquidity Event, the safe is junior to creditors and outstanding indebtedness (including outstanding convertible notes) and has the same priority as standard non-participating Preferred Stock.
Yes, investors can lose their investment in SAFE if the startup fails to raise a subsequent round of funding or sell the company.
What are the disadvantages of SAFE notes?
Lack Of Interest Payments: Unlike debt instruments, SAFE notes don't typically offer interest payments, which could be a disadvantage for investors seeking immediate returns. Investor Risk: In the case of a successful startup, investors might end up with a smaller equity stake compared to a fixed valuation.
Potential for Excessive Dilution: When SAFE notes convert, especially if multiple rounds have been issued, founders may face significant dilution of their equity. We've worked with a number of founders who ended up pretty surprised at how much of their company they sold and how little they actually own.
A SAFE (simple agreement for future equity) allows you to raise money from investors in exchange for future shares of stock in your company. SAFEs can be a convenient way to raise money when your company is young, however they can also be dilutive.
The SAFE will automatically convert to Shares in the same class as the preferred share investor(s). The SAFE holders will receive a share purchase agreement setting out certain limited representations with respect to the shares and will receive the conversion shares on closing of the Equity Financing.
Convertible notes and SAFEs are subject to a valuation cap. A convertible note is a capital-raising instrument that functions as a debt in the form of a firm loan. When a trigger event occurs, it changes into shares in that company.
