Successful investing is both an art and a science. Be weary of anyone who says otherwise. - Me
Companies and professionals love to use new acronyms and words to describe what they do. To anyone not immersed in a field, all the new verbiage can make you feel ignorant pretty quickly. In my experience, most of the time this is intentional and simply another means of job security.
In finance and investing, experts and regulators have used this tactic since the beginning of time. In the last decade or so, we’ve seen so many changes in the world of money, that even the experts these days have a very hard time keeping up.
Back in 2013, the crew at Y! (Y Combinator) released a document for dealing with equity investing. For those that do not know, Y Combinator has been a game changer over the decade in funding early stage startups. Their portfolio is a who’s who of huge players. I actually got the pleasure of talking to one of their investors over coffee about GCS and Mach1. It was a neat day but as you may have guessed, they did not invest millions in me…at least not yet.
The document they released that year was called a Simple Agreement for Future Equity and today, it’s widely used and best known for as another fancy acronym, a SAFE.
What is it?
SAFE’s were created essentially to allow for a simpler method of investing in early-stage companies. Today, they are used frequently in seed or angel investing and in fact, about 30% of my angel investing portfolio is using a SAFE agreement, and I would estimate about half of the deals I come across are structured that way.
The original intent of the SAFE was to replace convertible notes, which are debt instruments and as such, carry interest and maturity dates, dates that often require refiling if they expire which can be a pain. Since startups are very risky and nearly impossible to predict, a SAFE offers a shorter/easier way to take a bet that usually has a lot less complexity and legal mumbo-jumbo.
Just as is the case of an old-fashioned convertible note, a SAFE has terms that dictate when you are able to get equity (based on some event) but by themselves do not actually represent equity in a company. Because of this, you lose certain rights (state/federal/corporate) that you may otherwise have using different approaches. Also, since you do not own equity, it is very unlikely that you will have any voting rights in a SAFE.
Also, keep in mind that just like everything else, the devil is in the detail and each SAFE has a different set of parameters that determine if you will ever get equity and how much you will get. In fact, just because it has the word Simple in the title, many are anything but.
Simple is not always simple
Anyone who has ever handed an early-stage company a check understands how protective some founders are with their equity. Given this, it is not uncommon for a SAFE to have a variety of provisions, rules, triggers, and different configurations in the agreement. If there is anything I’ve learned from dealing with lawyers my entire life and reading hundreds of contracts/agreements, it’s that what I consider simple is vastly different than what the lawyers consider simple. A SAFE is no different and anyone considering an investment in this approach should read all terms very carefully.
Other things to remember
Seed/Angel/Startup investing is very risky, and 90% of investments end up giving you $0. A SAFE does nothing to change that fact. It’s not a magic bullet and if you are not comfortable with losing it all, you should avoid this approach entirely. If something sounds too good to be true, it almost always is.
Pay special attention to the trigger events that allow you to convert your investment into equity. Make sure you read and understand what the end game may be before making a decision. If you are playing the baseball game of life, it is great to try for a home run on occasion, but you will never get anywhere trying to score a touchdown. Make sure the trigger events are at least in the realm of possibility.
Just as any investment, always consider what happens if the company goes out of business (dissolution rights) or if the company can buy your future equity before it gets converted. Remember, your goal is to get as much money out of any investment and there are people on the other end trying to do the same.
Final Verdict
Ultimately, I tend to like the SAFE approach for early angel or seed investing. Overall, I’ve seen partnerships and deals vanish simply neither party could agree on equity provisions when the company was making less than $100K. If used properly, a SAFE can be a way to make the early decision easier, while only rewarding the investor if the company really takes off, which should be the goal of seed investing to begin with. One of the big reasons to use SAFE’s is speed, which for some, is important to give you the ability to pivot in what is now a breakneck-speed environment.
Note - The original SAFE was a pre-money safe, in some part because the money being raised was much smaller than it is now. In 2018, YC released a post-money safe which is a better overall approach overall. All of the SAFE deals I participate in are post-money.
For more information on SAFEs, I encourage you to check out this website.
Disclaimer: Always do your own research. If you make any financial decision based on what you read on the internet and you lose money, that is on you. That goes for my newsletter or Jim Cramer’s newsletter. This is not financial advice.