What Is a SAFE Investment Round for Startups?

A Simple Agreement for Future Equity, or SAFE, represents a foundational contract in the startup investment landscape. This financial instrument allows investors to provide capital to a company with the understanding that their investment will convert into equity at a later date. The primary purpose of a SAFE is to simplify the fundraising process for nascent companies by deferring complex valuation discussions. It provides a straightforward pathway for startups to secure initial funding without the immediate complexities often associated with issuing shares or taking on debt. A SAFE is fundamentally an agreement for future equity, signifying a promise of ownership stakes rather than a loan.

Fundamental Elements of a SAFE

SAFE agreements define terms for capital conversion into equity. A valuation cap is a common element, setting a maximum valuation for the company at which an investor’s SAFE will convert into shares. This protects early investors by ensuring they receive equity based on a predefined ceiling, even if the company’s valuation significantly increases. For instance, if an investor contributes $100,000 to a startup with a $5 million valuation cap, and the subsequent priced round values the company at $10 million, the investor’s shares will convert as if the company was valued at $5 million.

A discount rate is another important feature, allowing early investors to acquire shares at a reduced price compared to future investors in a qualified financing round. This discount rewards investors for their early commitment and the greater risk assumed at a startup’s nascent stage. For example, a 20% discount means the SAFE investor will purchase shares at 80% of the price paid by new investors.

Some SAFE agreements include a Most Favored Nation (MFN) clause. This clause stipulates that if the startup later offers more favorable terms (such as a lower valuation cap or a higher discount rate) to subsequent SAFE investors, the initial SAFE holder can elect to receive those better terms.

Pro-rata rights grant investors the option to participate in future equity financing rounds. These rights allow the investor to purchase additional shares to maintain their ownership percentage in the company.

The Conversion Mechanism

The conversion of a SAFE into equity is typically triggered by a “qualified financing event,” which is usually the company’s first priced equity financing round, such as a Series A. The company’s valuation is formally established, determining the price per share. Other trigger events can include a change of control, such as an acquisition, or even a dissolution of the company before a financing round.

Share calculation depends on whether a valuation cap, discount rate, or both are in place.

Valuation Cap Conversion

If only a valuation cap exists, the SAFE converts at the lower of the valuation cap or the company’s valuation in the priced round. For example, if an investor put in $100,000 with a $5 million valuation cap, and the Series A round values the company at $10 million with a price of $1.00 per share, the SAFE converts as if the company was valued at $5 million. The conversion price per share would be $0.50 ($5 million cap / $10 million valuation $1.00), meaning the investor receives 200,000 shares ($100,000 / $0.50).

Discount Rate Conversion

When only a discount rate is present, the SAFE converts at a discounted price relative to the per-share price of the priced round. For instance, if an investor invested $100,000 with a 20% discount, and the Series A price per share is $1.00, the SAFE converts at $0.80 per share ($1.00 (1 – 0.20)). The investor would then receive 125,000 shares ($100,000 / $0.80).

Both Cap and Discount Conversion

If a SAFE includes both a valuation cap and a discount rate, the investor typically benefits from whichever term results in a lower effective price per share, thus yielding a greater number of shares. The conversion mechanism compares the price derived from the valuation cap with the price derived from the discount rate, and the investor receives shares based on the more favorable outcome. For example, if the valuation cap yields an effective price of $0.50 per share and the discount rate yields $0.80 per share, the investor converts at $0.50, securing more equity.

In scenarios where a change of control or company dissolution occurs before a qualified financing round, the SAFE agreement outlines specific provisions. Investors might have the option to receive a cash payout equal to their original investment, or their SAFE could convert into common stock at a predetermined valuation for the purpose of the liquidation event. These provisions ensure a resolution for the investor even if a traditional financing round does not materialize.

Variations of SAFE Agreements

SAFE agreements vary, structured with different core elements to suit startup and investor needs.

Cap Only SAFE

One common variation is the “Cap Only SAFE,” which includes a valuation cap but does not feature a discount rate. This type is used when a valuation cap is sufficient to protect early investors.

Discount Only SAFE

Conversely, a “Discount Only SAFE” incorporates only a discount rate, providing investors with a reduced price on future shares without setting an explicit valuation ceiling. This structure is favored when future valuation is uncertain, incentivizing investors with a guaranteed discount.

Cap and Discount SAFE

The “Cap and Discount SAFE” combines both a valuation cap and a discount rate, offering investors the benefit of whichever term provides a more favorable conversion price. This hybrid approach is widely adopted, providing dual protection and incentive.

MFN Only SAFE

A less common variation is the “MFN Only SAFE,” relying solely on the Most Favored Nation clause. In this type of agreement, there is no predetermined valuation cap or discount. Instead, the investor is guaranteed to receive the most favorable terms that the company offers to any subsequent SAFE investors.

Key Distinctions from Convertible Notes

SAFEs and convertible notes are early-stage funding instruments with fundamental structural differences.

Debt vs. Equity Classification

A SAFE is explicitly an agreement for future equity, meaning it is not classified as a debt instrument. This contrasts with a convertible note, which is legally structured as a debt that has the option to convert into equity. This means a SAFE does not create a liability on the company’s balance sheet like a convertible note.

Maturity Dates

A key difference is their treatment of maturity dates. SAFEs generally do not have a maturity date, providing startups with indefinite flexibility regarding when the investment must convert or be resolved. Convertible notes, however, typically include a maturity date, ranging from 12 to 24 months, by which the debt must either convert into equity or be repaid to the investor. The absence of a maturity date in a SAFE removes the pressure of potential repayment obligations for the startup.

Interest Accrual

SAFEs do not accrue interest, unlike convertible notes which usually carry an annual interest rate (2-8%) that accrues over the note’s term. This accrued interest increases the amount that converts into equity or must be repaid, adding to the financial burden on the company.

Liquidation Preferences

SAFEs typically outline a simpler liquidation preference, often a 1x non-participating preference. This means investors receive their original investment back before common shareholders in a liquidation event, but do not participate further in remaining proceeds. Convertible notes can sometimes feature more complex or higher liquidation preferences, potentially granting investors a larger share of proceeds in a liquidation scenario.

Default Provisions

Finally, because SAFEs are not debt, they lack the default provisions commonly found in debt instruments. A convertible note, being a debt, can trigger default events if the company fails to meet its obligations by the maturity date, potentially leading to immediate repayment demands or even bankruptcy proceedings. SAFEs do not carry such immediate default risks, offering greater flexibility and less financial pressure on early-stage companies.