Once regarded as one of the investment community’s ‘stranger things’, SAFE Notes occupy the twilight zone between the usually binary alternatives of debt and equity. That is, unless certain events occur, they are neither. Whilst newer in Australia, these instruments have been around since 2013, when Californian start-up accelerator, Y Combinator, released the original SAFE document to the Silicon Valley investment community. Below we look at the mechanics of SAFE Notes and their benefits for Australian start-ups.
SAFE is an an acronym for ‘Simple Agreement for Future Equity’. A SAFE instrument is a legally binding agreement between a start-up entity and an investor. They were created as a simpler alternative to Convertible Notes and increasingly are presented to investors in a largely standard form of agreement, rather than being heavily and uniquely tailored to a specific company transaction.
SAFE Notes essentially investors the right to purchase equity in the company in the future. This means that they are not debt instruments and do not accrue interest. Instead, the investor provides funding to the start-up in exchange for a portion of future equity, often at the same time as the company’s first arms length priced round of equity financing (Qualifying Financing). When converted, the SAFE Note investment is measured against the Qualifying Financing round and typically attracts a discount of 10% to 30%. In addition, the Qualifying Financing round valuation may be subject to a ceiling or a cap.
Below are the key elements of how a typical SAFE agreement works under Australian law.
1. Qualifying Financing: The SAFE Investment Amount automatically converts to equity at a discount to the next Qualifying Financing round, with the amount of equity usually determined by four main factors:
2. Exit Event: Alternatively, if before the Qualifying Financing occurs, there is an Exit Event, the investor can choose to either receive:
3. Insolvency Event: If before the Qualifying Financing Event or Exit Event occur, there is an Insolvency Event, then:
There are a number of reasons why SAFE Notes can be appealing to start-ups.
As appealing as SAFE Notes look to be for early-stage companies, there are still some risks that companies and investors alike need to be aware of.
In an environment of increasing economic instability and uncertainty highlighted by the recent collapse of Silicon Valley Bank, Australian corporate software provider, Cake Equity, released data showing an increase in the use of SAFE Notes by start-up companies in Australia. With simpler terms and no maturity date, these once ‘strange things’ offer a flexible solution for Australian start-ups that is becoming increasingly popular and accepted.
At Edwards + Co Legal, we regularly advise on the suitability and terms and conditions of SAFE Notes. Early stage companies wondering if SAFE notes are right for them, or investors being asked to channel their investment through this kind of instrument, are welcome to contact us for advice as below.