SAFE

How a SAFE works

A SAFE is a one-document contract. The investor wires money now; the company promises shares later. Nothing happens on the cap table until one of three triggering events occurs, and Y Combinator's post-money safe user guide names all three: an equity financing, a liquidity event, or a dissolution event.

In an equity financing, conversion is automatic and the safe terminates. Y Combinator's guide is blunt about this: the safe holder has no choice about converting, because "a safe is intended to turn safe holders into stockholders." There is no minimum round size that has to be cleared first.

On the current post-money form, the number of shares comes from two divisions.

Safe Price = Post-Money Valuation Cap / Company Capitalization

Shares issued = Purchase Amount / Safe Price

Because the same Company Capitalization sits in both, the two divisions collapse into the line that makes the post-money form useful:

Ownership sold = Purchase Amount / Post-Money Valuation Cap

Y Combinator's quick start guide states this directly: the ownership sold equals the investment amount divided by the valuation cap, so 500,000 dollars on a 6.7 million dollar post-money cap is roughly 7.5 percent, and 1 million dollars is roughly 15 percent.

Company Capitalization is the defined denominator, and its contents are the whole argument. Per the user guide, it includes all issued and outstanding capital stock, all converting securities including other safes and notes, issued and outstanding options, promised but ungranted options, and the unissued option pool that exists before the financing. It excludes the option pool increase adopted as part of the equity financing. That is the substantive change from the original 2013 safe, where the cap was a pre-money cap, safes did not count each other, and the Series A pool increase was included. Y Combinator's stated reason for the change is that founders could not calculate their own dilution under the original form, because the answer depended on a recursive loop of other safes plus a pool increase that would be negotiated years later.

If the safe carries a discount instead of or alongside a cap, the discount applies to the price the new money pays.

Discount Price = price per share of the new preferred stock x (1 - discount rate)

When a safe has both, the investor converts at whichever of the two prices yields more shares. And even with a cap, the safe holder gets the better of the cap-implied price and the actual round price: if the financing prices close to or below the cap, the holder takes shares of the standard preferred at the round price and ends up with more equity than the cap alone implied.

The current standard forms are variants of one instrument: cap with no discount, discount with no cap, and an uncapped most-favored-nation version whose terms step up to match the best terms the company later grants another investor. A separate optional pro rata side letter gives the holder the right to participate in the round in which the safe converts.

Worked example

Suppose a founder owns 9,000,000 shares, employees hold 800,000 granted options, and 200,000 shares sit unissued in the pool. Company Capitalization before any new financing is 10,000,000 shares.

The founder raises two safes: 400,000 dollars at a 4,000,000 dollar post-money cap, then 600,000 dollars at an 8,000,000 dollar post-money cap. All figures are hypothetical.

Step one: implied ownership for each safe. The first safe is 400,000 / 4,000,000 = 10 percent. The second is 600,000 / 8,000,000 = 7.5 percent. The two do not dilute each other, because on the post-money form each safe's cap is stated after all safe money. Total sold on safes is 17.5 percent.

Step two: the founder and employees are diluted by the combined 17.5 percent, proportionally. Founder ownership falls from 90 percent of the pre-safe table to 90 x (1 - 0.175) = 74.25 percent.

Step three: a Series A arrives at a 20,000,000 dollar pre-money valuation, comfortably above both caps, so both caps apply. Company Capitalization counts the converting safes themselves, so it is not the 10,000,000 pre-safe count but that count grossed up for the 17.5 percent sold: 10,000,000 / (1 - 0.175) = 12,121,212 shares. Safe Price for the first safe is 4,000,000 / 12,121,212 = 0.33 dollars per share, giving 400,000 / 0.33 = 1,212,121 shares. Safe Price for the second is 8,000,000 / 12,121,212 = 0.66 dollars, giving 600,000 / 0.66 = 909,091 shares. Total safe shares: 2,121,212, which is 17.5 percent of 12,121,212, exactly as the shortcut predicted and exactly what step two implied.

Step four: the Series A investor buys 25 percent of the post-financing company and the round adds an option pool increase equal to 10 percent post-financing. Both the safes and the founders are diluted by that 35 percent. The safes' 17.5 percent becomes 17.5 x 0.65 = 11.4 percent, and the founder's 74.25 percent becomes 48.3 percent.

Step five: the trap. If the Series A had priced at a 4,500,000 dollar pre-money instead, the round valuation would sit below the second safe's 8,000,000 cap, and the user guide is unconditional about that case: the holder always receives more shares at the price the new money pays, and the cap does not apply. The first safe's 4,000,000 cap is below the round valuation, so it is the closer call, decided by the size of the pool increase. Caps are ceilings on price, not floors on the company's outcome.

Where it shows up

The SAFE is unusual among venture instruments in that the operative language is public and short.

In the safe itself, Section 1 sets out the three events. Section 1(a) covers the equity financing and directs that the investor receives a number of shares of safe preferred stock equal to the purchase amount divided by the safe price, with a comparison against the standard preferred price. Section 1(b) covers a liquidity event, where the user guide explains the holder receives the greater of a return of the purchase amount or the as-converted proceeds. Section 1(c) covers a dissolution event, where the holder is entitled to its purchase amount back. Section 2 holds the definitions that do the work, including Company Capitalization, Liquidity Capitalization, Safe Price and Promised Options.

On the cap table, an outstanding safe is not a share. It sits in a convertible instruments block with purchase amount, cap, discount and date, and appears as as-converted percentage only in the pro forma view.

In the priced round that follows, the safes surface on the capitalization schedule attached to the stock purchase agreement, in the form the National Venture Capital Association model documents use, and in the closing pro forma cap table attached to the financing documents. Safe holders are usually issued a shadow series, for example Series A-1 alongside the new Series A, identical in rights but priced at the safe price, with a liquidation preference equal to the purchase amount.

In the pro rata side letter, the right is to participate in the equity financing in which the safe converts, not the round after. That is a deliberate correction: the original safe's built-in pro rata right applied to the following round, which the user guide says both founders and investors routinely misread.

Common mistakes

• Reading a post-money cap as a pre-money cap. On the post-money form, 1,000,000 dollars at a 10,000,000 dollar cap is 10 percent, not 9.1 percent.
• Assuming safes dilute each other. On the post-money form they do not. Each one's percentage stands, and they are all diluted together by the priced round.
• Stacking safes without a running total. The guide's own arithmetic is that raising the full cap amount on a safe drives founder ownership to zero. Four raises that each feel small can commit a quarter of the company before a term sheet exists.
• Forgetting the round's option pool increase. Safes are not diluted by options granted before the financing, but they are diluted by the pool increase adopted as part of it.
• Expecting the cap to be the price. If the round prices near the cap, the holder converts at the round price and takes more shares, not fewer.
• Granting pro rata side letters to everyone reflexively. Allocations to safe holders plus new money plus the pool refresh can exceed the dilution the founder planned for.
• Calling a SAFE a note. It has no interest, no maturity and no repayment right outside a dissolution event, so none of the workarounds developed for notes apply.

Related terms

A SAFE is the main alternative to a convertible note and the usual instrument at pre-seed and seed round, converting at a priced series A. Its terms are read on the cap table, where the resulting dilution shows up, alongside the option pool and the preferred stock it converts into. The cap is quoted against a post-money valuation, and the optional side letter grants pro rata rights.

Frequently asked questions

What is a SAFE note?

There is no such thing as a SAFE note, strictly speaking, though the phrase is common. A SAFE, or simple agreement for future equity, is a contract to issue shares later in exchange for money now. It is not debt: no interest accrues, there is no maturity date, and the company has no obligation to repay outside a dissolution event. The "note" in the phrase is a holdover from the convertible notes SAFEs replaced.

How does a Y Combinator SAFE convert?

Automatically, at the company's next priced preferred stock financing. The holder receives shares of a shadow series priced at the safe price, which is the post-money valuation cap divided by Company Capitalization, or shares of the new preferred at the round price if that yields more shares. In a sale of the company or an IPO, the holder instead takes the greater of its money back or its as-converted share of proceeds.

What is the difference between a pre-money and post-money SAFE?

The pre-money safe, introduced in 2013, stated its cap before the safe money, excluded other safes from the conversion denominator, and included the priced round's option pool increase. The post-money safe, which Y Combinator standardized on in 2018, states the cap after all safe money, includes other safes and notes in the denominator, and excludes the round's pool increase. The practical effect is that the post-money form fixes the investor's percentage until the priced round dilutes it.

Is a SAFE better for founders or investors?

The post-money form moved certainty toward the investor: the buyer knows the percentage bought on the day of signing. Founders gained a different thing, which is the ability to calculate their own dilution before signing rather than after. Whether any specific SAFE is favorable depends entirely on the cap relative to what the company would price at.

What happens to a SAFE if the company is acquired before a priced round?

The acquisition is a liquidity event. The holder receives the greater of a return of the purchase amount or the proceeds it would get had the purchase amount converted to common at the post-money valuation cap, using Liquidity Capitalization as the denominator. That denominator excludes the unissued option pool, because an acquirer only buys outstanding equity. The safe ranks behind debt and alongside non-participating preferred.

Do SAFEs expire?

No. A safe has no maturity date and can stay outstanding indefinitely. It terminates only when the holder has received stock, cash or other proceeds through an equity financing, liquidity event or dissolution event. This is the main structural difference from a convertible note, which matures and then has to be repaid, extended or renegotiated.