Y Combinator’s Simple agreement for future equity (Safe) was created as an alternative to convertible debt and seed equity financing for startup companies. The Safe is a manifestation of Paul Graham’s concept of high resolution fundraising, which contends that startup financing is more efficient if companies can close different investments (sometimes at varying price and other terms) on a rolling basis with different investors. The Safe embodies this concept, while seeking to provide reasonable contractual protections for investors.
In the words of Carolynn Levy, the YC partner and former Wilson Sonsini lawyer who drafted the Safe, “[t]he Safe is just a convertible note with the ‘event of default,’ interest, and maturity date provisions stripped out. It is a convertible security with a creative acronym.”
Since the Safe’s release in December 2013, the startup community has engaged in a lively debate over the instrument’s benefits and drawbacks, including comments by lawyers here, here and here; venture capitalists here, here and here; and a Wall Street Journal article here. The Cooley law firm has created a Safe financing documents generator and Practical Law has developed its own form of Safe.
The main argument against the Safe from investors is that it lacks the maturity date, interest rate and certain other protections commonly associated with convertible notes or seed equity. While this is true as to the standard form Safe, an increasing number of my clients seem to be determining that the benefits, efficiencies and flexibility of the Safe outweigh the marginally greater investor protections and complexities of convertible notes and seed equity. These Safe benefits include the following:
- The Safe is a simple, short and sweet document – 5 pages! Compare this to the typically more complex convertible note or seed equity financing, the latter which requires drafting and negotiation of an amended certificate of incorporation, investors’ rights agreement, stock purchase agreement, etc.
- The Safe can be tailored to include a valuation cap, a discount or both (or neither), allowing it to be easily customized for the investor. Customizations may also include additional protections for major investors, such as rights of first offer (ROFO), observer rights, information rights and other rights.
- The Safe is not debt, so a standard Safe has no interest payable and no maturity date, which generally excludes these issues from the negotiating table.
- The preferred stock issued to a Safe investor on conversion has a liquidation preference equal to the amount the investor paid for the Safe, so the company is not unjustly burdened (and the investor is not unjustly enriched) with liquidation overhang.
- The form Safe was first released in December 2013, allowing the market adequate time to familiarize itself with the Safe, expediting negotiation.
The above benefits of the Safe mean that the closing of a Safe investment can sometimes be accomplished very quickly: I recently helped one of my clients close a Safe financing (with cap and discount) in 3 days. This translates into faster access to capital markets for startups and lower legal fees, which to me is not only high resolution fundraising, but high velocity fundraising.
In an effort to make Safe fundraising even more efficient for startups and investors, I have created a Simple Safe Spreadsheet, which hypothesizes various economic results for companies and investors using the Safe. The results include the preferred shares issuable to an investor upon the occurrence of an “Equity Financing” (e.g., Series A) at a given pre-money valuation and offering amount and the cash payable to an investor upon the occurrence of a “Liquidity Event” (e.g., sale of the company) for a given purchase price. The capitalized terms in the spreadsheet are the same as the defined capitalized terms in the Safe to facilitate cross-referencing and analysis. The spreadsheet’s results should be identical to the results given in Safe Primer examples if the Primer’s assumptions are used in the spreadsheet (allowing for slight variation due to rounding).
My hope is that this spreadsheet will help startups and investors continue to achieve high velocity fundraising using the Safe, which ultimately benefits the entire startup community.