Is SAFE debt or equity?
No, a
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.
However, SAFE notes contain several modifications that are intended to simplify the traditional process of convertible equity financing. Most importantly, unlike convertible notes, SAFE notes are not a loan or a debt instrument.
Depending on the type of SAFE (pre-money vs. post-money) and some of the factors related to the SAFE's issuance, a SAFE will usually be treated as either an equity or an equity derivative for tax purposes.
Instead, a SAFE note represents a right to purchase equity in the company at a future date, typically when the company raises its next round of financing or goes public. As a result, investors typically expect companies to classify SAFE notes as equity on their balance sheets.
Key Takeaways. Simple agreements for future equity, or SAFEs, are flexible agreements providing future equity rights without immediate valuation. SAFEs are commonly used for early-stage startup funding. Conversion terms are triggered by specific events like equity funding rounds or acquisitions.
Some of the most common types of safe assets historically include real estate property, cash, Treasury bills, money market funds, and U.S. Treasuries mutual funds. The safest assets are known as risk-free assets, such as sovereign debt instruments issued by governments of developed countries.
The term “equity” refers to ownership in a business that is typically expressed as a percentage of the total shares of a company. A SAFE is a legal contract that gives the investor the right to purchase equity in the future.
SAFE notes also lack an explicit repayment obligation, making them more favorable for startup founders. Equity vs debt. SAFE notes prioritize the future conversion of investment into equity, while convertible notes often prioritize debt repayment.
A note is a debt security obligating repayment of a loan, at a predetermined interest rate, within a defined time frame. Notes are similar to bonds but typically have an earlier maturity date than other debt securities, such as bonds.
What happens if a SAFE note never converts?
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.
For income tax purposes, taxpayers have usually classified SAFEs as debt, equity or prepaid forward contracts. With respect to debt or equity classifications, SAFEs lack many of the indicia of true debt or equity instruments.
If you want to use SAFEs for fundraising, your startup must be designated as a C-Corp, which means you have a defined ownership structure and must pay corporate income taxes on profits and losses. LLCs may be able to raise SAFEs in some circ*mstances, but the procedure is more difficult.
Generally, when a company receives funds from a SAFE note, the journal entry would be as follows: Debit “Cash” (an asset account) to reflect the inflow of funds from the investor.
- Determine conversion terms (valuation cap, discount rate, and/or pro-rata rights)
- Calculate the number of shares issued to SAFE investors.
- Record conversion by debiting “SAFE Equity” account and crediting “Common Stock” and/or “Preferred Stock” accounts.
Fair value is generally assumed to be the transaction price at issuance. For instance, if a $50,000 SAFE note is issued, the fair value on the issuance date is assumed to be $50,000.
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.
Is a convertible note debt or equity? Convertible notes are originally structured as debt investments, but have a provision that allows the principal plus accrued interest to convert into an equity investment at a later date. This means they are essentially a hybrid of debt and equity.
Additionally, SAFE note investors don't receive dividends. Profits are typically reinvested back into the company, so don't expect to see any returns until the company is either sold or goes public. Valuation Cap complications: The valuation cap is a way to reward early investors if the company does well.
Treasury bonds have long been considered the financial markets' “safe haven” asset. That remains generally true, but investors should appreciate the risk of default is causing the financial markets to re-assess Treasuries' superiority as a safe haven relative to other assets.
What is the safest investment with the highest return?
- Certificates of deposit (CDs) and share certificates.
- Money market accounts.
- Treasury securities.
- Series I bonds.
- Municipal bonds.
- Corporate bonds.
- Money market funds.
- Dividend stocks.
- Stocks.
- Real Estate.
- Private Credit.
- Junk Bonds.
- Index Funds.
- Buying a Business.
- High-End Art or Other Collectables.
In general, stocks are riskier than bonds, simply due to the fact that they offer no guaranteed returns to the investor, unlike bonds, which offer fairly reliable returns through coupon payments.
Is Debt Financing or Equity Financing Riskier? It depends. Debt financing can be riskier if you are not profitable as there will be loan pressure from your lenders. However, equity financing can be risky if your investors expect you to turn a healthy profit, which they often do.
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.
