What is a SAFE agreement and how does it work?

Full Explanation

The SAFE was created by Y Combinator in 2013 as a simpler alternative to convertible notes for early-stage fundraising. Unlike a convertible note, a SAFE is not debt — it has no interest rate, no maturity date, and no repayment obligation. It is simply a contractual right to receive equity in the future when a triggering event occurs (typically a priced equity financing round). SAFEs typically include two key economic terms. The valuation cap sets the maximum valuation at which the SAFE converts to equity — if the company raises at a higher valuation, the SAFE holder converts at the cap, receiving more shares per pound invested. The discount (commonly 15-25%) gives the SAFE holder a percentage reduction on the price per share paid by new investors. Some SAFEs include both mechanisms, with the investor receiving whichever produces more shares. For example, an investor puts £100,000 into a SAFE with a £5 million cap and 20% discount. If the Series A prices the company at £10 million, the SAFE converts at the £5 million cap (the more favourable term), giving the investor twice as many shares as the Series A investors per pound invested. SAFEs are founder-friendly because they avoid the complexity and legal costs of priced rounds, have no maturity date pressure, and do not accrue interest. However, founders should understand the dilution implications: multiple SAFEs with low caps can create significant dilution at conversion. The post-money SAFE (Y Combinator's current standard) made this more transparent by defining the cap as post-money, meaning the investor's ownership percentage is known at the time of investment.

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