What SAFE can – and cannot – do for you

Recently I have been getting more requests to review SAFE (Simple Agreement For Equity) offers, which according to Wikipedia are based on Y Combinator’s open source alternative to convertible notes. Clearly, the promise of simplicity (and by implication, lower transaction costs) makes it an attractive starting point, but unfortunately I had to frequently upset the potential client by telling them that the documents didn’t reflect their aspirations well.

To be fair to Y Combinator, they do clearly describe the purpose of SAFE – for early stage fundraising simultaneously with multiple investors, and to limit negotiations to the valuation cap so that there is certainty and transparency for both founder and investor. They also suggest that users obtain legal advice in the relevant jurisdictions especially where the parties involved are not based in the US. However there is no way to prevent users from taking the template and running wild with additions and amendments to fit it in their own situation, and then try to get lawyers to bridge the gap between SAFE and the appropriate relationship in an attempt to save costs.

SAFE is not intended to work (without heavy modification) in the following common situations:

1.Where an investor wants to preserve the current composition of shareholders

The whole point of SAFE is to expedite future rounds of fundraising by issuance of new shares. Therefore an investor who receives a draft based on SAFE can’t expect to be given rights that would allow him the first pick in future share issues, since his interest against dilution of his shareholding would be made secondary to the company’s interest in future fundraising.

Aside from limiting the rights of the company in issuing new shares, an investor may also want to avoid having current shareholders transfer their shares to third parties, resulting in fragmentation of shareholding which could make gathering consensus difficult. They would need to extend their first right of refusal to the current shareholders, or their estate in cases of involuntary exit, so they have the opportunity to keep the shareholders community small and private.

2.Where a potential investor also wants an active role in the company’s business

This desire is also strongly correlated with a situation where the shareholders are few in number and tight knit – if they want to work together and have the right to actively manage the company’s business, SAFE would not be a suitable structure. They should expect a draft agreement to contain clauses such as rights to appoint directors, reserved matters clauses to ensure that unanimity is required for certain matters and even sign separate agreements for services or employment to cement their operational roles.

3.Where a potential investor wants to exit in a variety of events

SAFE does cater for investors to exit from the company when it reaches a particular valuation or winds up. However, investors may also want other options to exit, especially if they do not want to remain in the company with strangers, such as tag along rights (to be brought out by a third party at the same time as another shareholder).

Another common point of exit is when the shareholders cannot get their act together, and the company gets paralysed by non-cooperation or indecision. Of course, having clauses to deal with such deadlock situations also presume that the investor wants to have an active role in the company’s affairs, and therefore wants to get off a train heading to nowhere.

Templates are tempting but they usually serve narrow purposes. The allure of SAFE has to be tempered by the discipline to only use it in situations which it was designed for. Investors who want more say and control over the direction of the company would probably be better off getting a bespoke agreement done, rather than trying to Macguyver a working arrangement.