Startup Capital Raising with SAFE Notes
A SAFE (Simple Agreement for Future Equity) note is an instrument introduced by YCombinator, an accelerator based in Silicon Valley. The model was developed as an alternative to convertible bonds or notes, a type of bond which converts a specified number of shares into equity. Though convertible notes and SAFE notes are both forms of hybrid security with debt and equity features, SAFE notes are being hailed as simpler and more convenient to use.
Due to its’ relative newness and infrequent use in the Australian startup ecosystem, some founders are hesitant to approach SAFE notes. Despite concerns, SAFE notes are gaining popularity as alternatives to convertible notes. At Allied Legal, we have decoded some of the mysticism of SAFE notes. We highlight the uses, key features and benefits below:
What is a SAFE Note?
A SAFE note is an instrument which founders can issue in exchange for capital, which gives investors the right to purchase stock in the company at a later date subject to the parameters of the SAFE. SAFE shares are of undetermined value in exchange for equity, meaning no share price is determined at the time of the capital raise. Instead, investors can convert the shares into equity when a trigger event occurs or during the next round of funding. If the startup never reaches the trigger event, no shares are allocated.
Under a SAFE note agreement, founders can issue valuation caps. In Australia, some SAFE notes do not require a valuation cap, however where a valuation cap is provided for, the valuation cap will have a maximum number at which can be converted. Startups can also issue discount rates, enabling investors to buy shares at a reduced rate. This incentivises investors to offer capital during a startup’s infancy. To ensure that you are offering suitable discount rates, it is recommended that you consult a startup lawyer.
- Simplicity: SAFE notes are concise and simplistic. The documentation is typically between 5-10 pages and simple to prepare, particularly if you consult a startup lawyer to assist you with the process.
- Flexibility: Unlike convertible notes, a SAFE note is not a debt instrument. Startups are not required to pay interest and there is no maturity date or repayment obligation. This flexibility means that startups can operate without limitations and fears of insolvency.
The newness of SAFE notes, in addition to concerns surrounding an investors control over the timing of the capital raising, means that it is yet to gain significant traction in Australia’s startup ecosystem. Despite this, SAFE notes continue to increase in popularity due to its simplicity and flexibility. SAFE notes are particularly beneficial for early-stage startups, who want to delay valuing their startup. If you need further guidance on how to best employ SAFE notes, you can speak with a startup lawyer.
Need Help? Contact Us
At Allied Legal we ensure that startups receive the best outcomes when dealing with investors. If need assistance drafting a SAFE note or if you need advice on capital raising, give us a call on 03 8691 3111 or send us an email at firstname.lastname@example.org.
You might also like our article Leveraging Startup Culture for Success.