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SAFE Notes: Capital raising for early-stage start-up companies – Securities

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A common hurdle faced by many early-stage start-ups is trying to
raise capital where the company has not yet attained sufficient
financial information and/or market data in respect of the
business, which makes it difficult to assign a justifiable and
substantiated value to the company.

SAFE (simple agreement for future equity) notes are documents
that start-ups may consider using to help raise seed capital where
there is limited financial data, and or a consistent source of
revenue over a tracked period of time.

A SAFE note is a legally binding promise that allows an investor
to purchase a specified number of shares for an agreed-upon price
at some point in the future.

How SAFE Notes Work

For most start-up companies there is typically very little
financial information and/or market data in respect of the
business, making it difficult to assign the company any value. SAFE
notes work by allowing you to postpone your company’s valuation
until a later date (the post-money event).

Example of how a SAFE Note works:

  1. An investor provides seed money to a start-up in exchange for
    promised future equity in the entity;

  2. The company uses the original investment to build the

  3. Once another investor invests in the company (known as
    post-money valuation), the company can calculate a new price per
    share using the information;

  4. After the share price is known, the company can convert the
    SAFE note into the applicable number of shares in the company, and
    distribute them to the SAFE investor.

Key Elements in a SAFE Note

SAFE notes contain a few primary terms that alter how they
eventually convert to company shares, and they are:

  1. Discounts: SAFEs sometimes apply discounts,
    usually between 10% – 30%, on future converted equity. This means
    that the investor will be able to purchase shares at a discount on
    the future financing.

  2. Valuation Caps: Valuation caps are a term in
    SAFE notes that establish the highest price, or cap, that can be
    used when setting the conversion price.

  3. Most-Favoured Nation Provisions: Where there
    are multiple SAFEs, this term requires that the company notify the
    first SAFE note holder, including the terms for the subsequent
    note. If the first SAFE holder finds the second SAFE’s terms to
    be more favourable, they can ask for the same terms.

  4. Pro-Rata Rights: Pro-rata, or participation
    rights, allow investors to invest extra funds so that they can keep
    their percentage of ownership during future equity financing.

Types of SAFE Notes

When issuing a SAFE note, you can choose from four different

  1. No valuation cap and no discount

  2. A valuation cap and a discount

  3. A valuation cap, but no discount

  4. A discount, but no valuation cap

The Advantages of Using SAFE Notes

Simple and less complex documents

One of the primary benefits of SAFE notes is that they are
typically short and simple agreements with fewer commercial items
to negotiate. The key items to be negotiated are the discount rate
and the valuation cap. SAFEs are meant to be simple arrangements
with fewer terms to negotiate, making everything that needs to be
discussed clear and concise.

Key triggers on certain events

SAFEs protect both start-up companies and investors by including
key agreements for potential future occurrences, such as:

  • Changes of control

  • Early exits by investors and company owners

  • Company dissolution

Simple accounting requirements

SAFE notes are included in a company’s capitalisation table,
eliminating the need for any complicated tax consequences.

Better benefits for investors

Since SAFE notes are converted into shares, often at a discounted
price, investors have a lot of incentive to use them.

There are risks to using SAFE Notes

Because a SAFE note’s outcome depends on how the company
performs, investors don’t have a guarantee that it will ever
convert into equity.

No interest paid on monies advanced

SAFE notes do not provide investors with interest payments on the
monies advanced.

No dividends paid until notes convert to

The investor pays funds upfront for a SAFE Note, which is a promise
to receive equity in the future. Only once the equity is issued in
the investee company will the investor be entitled to receive
dividends (if any) when declared by the company.

If you are thinking of raising capital or looking to invest in a
start-up, always seek legal and financial advice.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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