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Why Simple Agreements for Future Equity (SAFEs) are Not Always Safe
September 18, 2019
Why Simple Agreements for Future Equity (SAFEs) are Not Always Safe

Entrepreneurs have a myriad of options for raising capital for their early-stage businesses including bootstrapping, crowdfunding, issuance of common stock, and issuance of convertible notes. Among these options is the Simple Agreement for Future Equity (SAFE). SAFEs debuted in 2013 and since rapidly gained popularity among founders and investors alike due in part to its simplicity. Despite its popularity and simplicity, SAFEs can present several dangers to the involved parties.

SAFEs are instruments that function similarly to a warrant. In exchange for capital, SAFEs memorialize the agreement with the investor that upon a subsequent round of equity financing, upon a change of control of the company, or a company’s initial public offering, the investment amount of the SAFE will convert into equity in the company. Although similar in function, SAFEs differ from convertible notes insofar as the amount invested under a SAFE is not debt that accrues interest or requires a monthly payment, nor does it have a maturity date. SAFEs are not immediate equity interests in the company, but rather a promise that the investment amount will convert into equity in the future. This aspect of SAFEs presents investors a fundamental concern. Investors are not afforded any protections under state corporate law or federal securities law, as would be applicable in the event equity was issued, nor can they seek recourse absent of fraud or some other contractual cause of action in the event the SAFE does not convert.    

Further, a SAFE can remain outstanding indefinitely, which would prevent the investor from realizing any gain on the investment. Because SAFEs are designed to convert only upon the occurrence of certain specified events, an investor must analyze the risk that the events may not occur in light of the circumstances of the company. If a company generates enough capital to not need any additional rounds of equity financing, the invested amount under the SAFE may never convert to equity.

A common misconception is that SAFEs are standardized. Although YCombinator, the seed accelerator that created SAFEs, publishes standardized versions of the agreements on its website, these documents can, and often are, modified by the issuers. An attorney is best able to review the SAFE to advise the investor of the effects of the specific document, such as: (1) the conversion terms including the amount and conditions for conversion and the likelihood of such conversion; (2) the repurchase rights of the company and whether the company may be able to prevent conversion of the investment in exchange for repurchasing the SAFE from the investor; (3) any dissolution rights in the event the company files for bankruptcy prior to conversion; and (4) voting rights, if any, afforded to the investor.

Should you have any questions regarding Simple Agreements for Future Equity or other equity financing matters, the attorneys of Parker McCay’s Corporate and Commercial Lending Departments are available to assist.

The content of this post is for informational purposes only and should not be construed as legal advice or legal opinion. You should consult a lawyer concerning your specific situation and any specific legal question you may have.

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