The Guide to SAFE Agreements: Navigating Equity in the US, UK, and AU

Funding can be a complex puzzle to solve, with several options on the table for scaling companies. From convertible loan notes to large-scale VC investments, businesses need to weigh financial gains against equity sacrifices, taxation, shareholder interests, and more.

Among the plethora of options, the Simple Agreement for Future Equity, or SAFE agreement, has become a popular funding instrument that can simplify early-stage financing. 

In this guide, we explore the nuances of SAFE agreements and how they, and similar funding instruments, operate in the US, AU, and UK. We'll discuss:

• What are SAFE agreements?
• Where did SAFE agreements originate?
• Why was the SAFE agreement created?
• When should you use a SAFE agreement?
• What are the pros of a SAFE agreement?
• What are the cons of a SAFE agreement?
• What are the different types of SAFE agreements?
• How do SAFE agreements differ between the UK, AU and US?
• Advanced subscription agreement vs SAFE
• Best practices for startups using SAFE agreements
• Key trends and figures for SAFE agreements

What are SAFE agreements?

SAFE agreements offer a flexible mechanism for startups to secure investment without the immediate need to determine the company's valuation. This can be particularly useful in the early stages of a company's development, where valuations can be more speculative. With a SAFE agreement, the investor provides funding to the startup, and in return, they receive a promise of future equity. In some ways, it is similar to funding mechanisms like convertible loan notes, but with some key differences.

Unlike convertible notes, a SAFE agreement does not accrue interest and does not have a maturity date, which means there's less pressure on the startup to repay investors within a fixed timeline. Convertible notes typically convert into equity at a future financing round, similar to SAFEs, but they include debt terms such as interest rates and repayment schedules. This can add complex layers that early-stage startups especially, might prefer to avoid. 

This absence of debt-like features makes SAFEs a more founder-friendly option. 

Investors, on the other hand, won’t have to worry about the startup defaulting on repayment or having to renegotiate terms since there are no maturity dates. Like Convertible Notes, they are still compensated for taking on the higher risk of an early-stage investment through provisions such as valuation caps and discounts, which reward them with more equity if the company achieves future financing rounds at higher valuations. 

Where did SAFE agreements originate?

Introduced in 2013 by American tech startup accelerator, Y Combinator, SAFE agreements have quickly become a popular alternative to traditional convertible notes. They were designed to simplify the investment process while providing key benefits to founders and investors. 

The key aspects of a SAFE agreement typically include the investment amount, any applicable valuation cap or discount rate, and the triggering events that allow for the conversion of the SAFE into equity. These customisable terms have made SAFEs a key tool in the startup ecosystem, particularly in the US, Canada, Israel, and Australia. The UK's equivalent, Advanced Subscription Agreements, are similarly key to the scaleup funding environment - something we’ll touch on in more detail later.

Why was the SAFE created?

The SAFE was created to simplify the fundraising process for startups and investors. Traditional equity investment rounds can be lengthy and complex, often involving detailed negotiations over valuation, control rights, and legal nuances. The SAFE was designed as a more straightforward alternative to this process. In a nutshell, SAFE agreements were set up to:

• Enable founders to secure funding before determining their company's valuation.
• Simplify the fundraising process for startups.
• Reduce legal costs and save time for both founders and investors by reducing the need for custom agreements.
• Provide a more straightforward option compared to convertible notes and other funding methods.

When should you use a SAFE agreement?

SAFE agreements are particularly useful during the early stages of a startup, often at the pre-seed or seed funding rounds, when it can be challenging to determine an accurate company valuation. Since a SAFE agreement postpones the need to set a valuation until the next priced round, it provides a flexible option for startups eager to quickly secure investment.

You might also consider using a SAFE agreement if you're looking to streamline investment negotiations. They are designed to be more simple and straightforward than alternative methods, reducing the need for prolonged discussions over terms. Similarly, if you anticipate rapid growth, these agreements can allow for faster fundraising so you can focus on scaling your business without becoming embedded in prolonged legal procedures. 

Another scenario where a SAFE might be useful is when you're eager to bring strategic investors on board without immediately altering your company’s ownership structure. By delaying the conversion of the investment into equity, you retain manoeuvrability in the early days when strategic decisions are crucial.

What are the pros of a SAFE agreement?

SAFE agreements provide several advantages that make them appealing to both founders and investors. Let's take these one by one.

• Simplicity: A SAFE is concise, which reduces negotiation time and lowers legal expenses. This allows startups to accelerate their fundraising process with less complexity.
  
  
• Flexibility: By opting for a SAFE, startups can delay setting a formal company valuation until a later date. This is particularly attractive during early-stage fundraising when an accurate company valuation can be challenging.
  
  
• Investor Incentives: SAFEs include terms like a valuation cap and discount rate, which can incentivise investors. A valuation cap provides investors with assurance that they will get a minimum share of equity if the company does particularly well. Similarly, a discount rate allows the investor to convert their investment to equity at a cheaper rate compared to future investors. 

What are the cons of a SAFE agreement?

While SAFE agreements can be a valuable tool for startups, they can come with some setbacks.

• Equity Dilution: A primary concern is the potential dilution of the founders' equity stake. Once the SAFE converts to equity, particularly in a successful future financing or liquidity event. While founders typically have a clear understanding of their cap table and expected dilution, the impact of multiple SAFEs issued across different funding rounds can be significant. Each SAFE converts based on its specific terms, such as valuation caps or discounts, which may lead to the issuance of a substantial number of new shares. As a result, even with careful planning, founders may see a notable shift in their ownership percentage once these conversions occur. To mitigate surprises, it’s essential to model various financing scenarios and assess the potential impact on long-term equity distribution.
  
  
• Potential Disputes: The simplicity of SAFE agreements can also be a blessing and a curse. As brief documents with fewer terms than traditional funding instruments, they might not fully cover the complexities of future financing events, leaving some elements open to interpretation. In other words, a recipe for disagreements and potential disputes.  This can cause complications down the line, especially if there is no shareholders' agreement in place to provide clarity.
  
  
• Riskier for Investors: The lack of debt characteristics means that SAFE holders do not have the same protections as convertible debt holders, such as the option to demand repayment. This can make SAFEs riskier for investors, which can narrow the pool of interested parties.
  
  
• Familiarity: Finally, while SAFEs are common in regions such as the US, they're not as widely accepted or understood in the UK and the EU. While there are alternatives (which we'll touch on below) this can pose a challenge for dealing with investors unfamiliar with the SAFE structure.

What are the features of SAFE agreements?

The features of SAFE agreements make them an attractive choice for startups, but what exactly are they? Here’s what you should know about their key elements: 

• Investment Amount: This is the capital provided by the investor in exchange for the potential to receive equity at a later date.
  
  
• Valuation Cap (Optional): A predefined ceiling that sets the maximum company valuation at which the investment will convert into equity. This can benefit investors in the event of significant company growth.
  
  
• Discount Rate (Optional): A percentage discount on the future equity conversion price, offering investors a preferential rate. Discount rates can vary quite significantly, but most commonly sit between 10% and 25%.
  
  
• Trigger Events: These are specific conditions under which the SAFE will convert into equity, typically a subsequent priced equity round, acquisition, or IPO.
  
  
• Conversion Terms: The terms under which the SAFE converts to equity can be influenced by either the valuation cap or the discount rate, offering flexibility in how conversion occurs.
  
  
• Pro-Rata Rights (Optional): These rights allow investors to maintain their ownership percentage by participating in future funding rounds.
  
  
• Most Favored Nation (Optional): These rights ensure that early investors receive terms at least as favourable as those offered to subsequent investors. If a company issues new convertible securities with more advantageous terms, such as a lower valuation cap or higher discount rate, the MFN clause allows the original SAFE investors to adopt these improved terms. This provision protects early investors from potential disadvantages if the company offers better terms to later investors. 

What are the different types of SAFE agreements?

SAFE agreements can come in several types to accommodate various investment scenarios. You're most likely to come into contact with the two main versions: pre-money and post-money SAFEs. According to Carta's State of Pre-Seed Q1 2024 report, post-money SAFEs have now become the ‘default’ type, responsible for 85% of agreements in early 2024.

Let's explore the differences between the two.

1. Pre-money SAFE agreements

The pre-money SAFE allows investors to purchase future equity in the company without specifying a valuation at the time of the agreement. This type of SAFE was the original version introduced by Y Combinator and does not fix the company's valuation until an ensuing equity round occurs. Instead, it allows investors to convert their SAFE into equity at a future date, based on predetermined conversion terms, such as a valuation cap or discount rate. 

The core advantage of a pre-money SAFE is its simplicity and speed. It reduces the need for detailed negotiations overvaluations, which can be particularly advantageous for early-stage startups seeking quick capital. Investors, on the other hand, gain easier entry into potentially lucrative startups without diving into traditional investment agreements. 

However, it's important to acknowledge that the pre-money SAFEs are not without limitations. Since the terms do not lock in current valuations, future equity dilution can - and does - vary significantly. This uncertainty can impact an investor’s final equity percentage when the SAFE converts. 

2. Post-money SAFE agreements

In a post-money SAFE agreement, the valuation cap or discount rate you negotiate with the investor is applied after other investments are accounted for. This means that the SAFE converts based on the fully diluted capitalisation of the company, including all SAFEs, convertible securities, and options, issued prior to this round. In other words, it provides the investor with a clearer picture of their ownership share post-conversion and offers you, as a founder, more predictability regarding your equity structure. 

One benefit of post-money SAFEs lies in their simplicity in calculating dilution, since the terms clearly define the investor's ownership stake upon conversion. However, this structure may mean a higher dilution for founders as you effectively reserve more future equity for SAFE conversions upfront. Importantly, this transparency can attract investors who prefer knowing their eventual equity position with more certainty.

How do SAFE Agreements differ between the UK, EU, and US?

So, how do SAFE agreements differ from region to region? Let's start with the birthplace of SAFE agreements: the US.

SAFE agreements in the US and AU

You can expect US investors to be familiar with SAFE agreements and their structure, and as a result (among many other benefits) they've become a popular choice among startups. They promise increased flexibility and simplicity,  don't accrue interest like convertible notes ,and typically exclude maturity dates, making them an attractive option for early US fundraising rounds. 

In Australia, SAFE agreements are a viable funding option for startups, although less popular than in the US, and they're regarded with notably more caution than in the States.

While the Australian Investment Council (AIC) provides a largely accepted standardised template of a post-money SAFE, guidance overwhelmingly recommends a bespoke approach to SAFE agreements to avoid unintended consequences. 

SAFE agreements in the UK

Moving onto the UK, SAFEs have equivalent instruments that comply with the local legal infrastructure. The UK most commonly employs Advanced Subscription Agreements (otherwise referred to as ASAs), which are similar but offer more protections. 

ASAs, much like SAFEs, allow for investment in a company in exchange for future equity. However, a key distinction lies in the provisions for investor protection. ASAs generally incorporate more detailed terms, addressing conversion conditions, valuation caps, discounts, and investor rights more comprehensively than the typical SAFE. This extra layer of detail reflects the UK's regulatory framework and the typical expectations of cautious UK investors. 

Another key point is that ASAs are often preferred in the UK because they can qualify for tax benefits under the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS). These schemes provide significant tax relief to investors, making ASAs a particularly attractive option.

While SAFEs can be an efficient way to secure funding quickly in the UK, they usually do not qualify for these tax advantages. 

Advanced subscription agreement vs SAFE

Let's break apart the differences between SAFE agreements and ASAs in closer detail.

• Conversion: SAFE agreements convert into equity on a future date, usually when a qualifying financing round occurs, while ASAs often include a long-stop date (a final deadline by which conversion must occur), ensuring shares are issued within a set timeframe.
  
  
• Complexity: SAFE agreements are intended to simplify the investment process and require less documentation, whereas ASAs usually involve a little more documentation to meet legal requirements.
  
  

Best practices for startups using SAFE agreements

Considering a SAFE agreement for your start-up? You'll want to follow best practice steps to fuel the best possible outcome.

• Clear Terms: First, clarity is your friend. Clearly define the key terms such as the investment amount, valuation cap, and discount rates. This will help both parties understand exactly what they’re signing up for.
  
  
• Legal Expertise: Despite available templates, overwhelming advice points towards enlisting the legal expertise of startup lawyers. As an instrument with the potential to impact the future of your company, consulting a lawyer who understands SAFE agreements - or ASAs - can prevent future disputes, misunderstandings, or unintended outcomes.
  
  
• Transparency: Keep your investors informed about company progress, including milestones and potential challenges. In doing so, you'll naturally foster trust and can even make future fundraising efforts easier.
  
  
• Goal Alignment: Reflect on how converting these agreements aligns with your business trajectory and how it might affect existing shareholder dynamics. Including SAFE holders in shareholder agreements right from the start can preemptively address potential issues at the conversion stage. 

Key trends and figures for SAFE agreements

SAFE agreements have increasingly grown in popularity since their introduction in 2013, and have quickly entered the global funding market thanks to their cost-effective alternative to traditional equity financing. As an instrument that's only set to further dominate markets, let's take a more detailed look at the stats behind SAFEs. 

• Rapid Adoption: SAFEs have quickly gained traction in Silicon Valley and beyond, and are now a particularly popular choice in the United States, with an increasing number of startups opting for them over convertible notes. So much so that in Q2 2024, 90% of rounds under $1 million were funded through SAFEs.
  
  
• Market Expansion in Europe and the UK: While the US still dominates the SAFE landscape, Europe's startup ecosystem is gingerly embracing this funding method. The maturation of the European startup scene is mirrored by the increasing use of SAFEs/ASAs, particularly in tech-intensive regions like London, Berlin, and Paris. Regulatory developments continue to shape their implementation, highlighting an adaptive market that's shifting to funding needs.
  
  
• Investor Confidence: The growing familiarity with SAFEs amongst investors has also led to broader acceptance and trust in these instruments. This trend in turn promotes faster deal closures and a reduction in time-to-funding, a vital factor for cash-sensitive startups.
  
  
• Valuation and Discount Trends: As the venture capital landscape becomes increasingly competitive, trends are similarly beginning to emerge in valuation caps and discount figures. In Q2 2024, 57% of SAFEs only included a valuation cap, 35% included both a valuation cap and discount, while the median discount sat at 20%. This trend is particularly noticeable in high-demand sectors such as fintech, biotech, and artificial intelligence, where investors are eager to secure a stake in promising companies before their valuation potentially skyrockets.
  
  
• Regulatory Influence: As SAFEs secure their place in the funding toolkit, various jurisdictions are evolving their regulatory frameworks to accommodate their use. This trend is helping to ensure that both issuers and investors are protected. In the US, continuous alignment with Securities and Exchange Commission (SEC) guidelines aids in maintaining the effectiveness of SAFEs.

Conclusion

SAFE agreements are evolving the way startups and investors collaborate, offering a flexible, straightforward, and efficient means of securing early-stage funding.

With their roots in Silicon Valley, these agreements offer startups a chance to grow without the constraints traditionally associated with raising capital, and yet, potential pitfalls lie in wait.

For those considering SAFE agreements, careful consideration of their potential downsides and legal frameworks is critical, alongside their operation on a global scale.

Considering SAFEs or ASAs? We're a team of expert lawyers highly experienced in scaling companies worldwide. Get in touch to see how we might support you. 

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