The SAFE Through the Lens of an Investor

When a startup raises capital by offering simple agreements for future equity (SAFEs) to investors, what do investors need to know? If you are considering investing in a startup through a SAFE, what do the cap discount and post-money mechanics mean for your ownership? Why do stacked SAFEs dilute earlier holders? And what should you keep in mind about any most-favored-nation (MFN) provisions? Our startup attorneys provide legal advice for individuals and entities associated with startups, and we can answer any questions you have about startup investment and SAFEs today. In the meantime, consider the following information about the SAFE through the lens of an investor.

Investor Ownership, the Cap Discount, and Post-Money Mechanics

What do the cap discount and post-money mechanics mean for your ownership in a startup? As JP Morgan explains, SAFEs are almost always post-money, which means that “the cap accounts for the SAFE itself, so investors know what slice of the company they are getting when they invest.” With a post-money SAFE, as an investor, your ownership stake is protected regardless of new SAFEs and new investors.

Stacked SAFEs and Dilution

For pre-money SAFEs, ownership can shift as additional investors come in through SAFEs. When this happens, SAFEs become “stacked” and dilution occurs — stacking is the term that describes a situation in which startups issue multiple SAFEs over time prior to a priced funding round rather than raising capital at once. Why does dilution occur? Stacked SAFEs gradually lock in a low valuation cap, and over time, cumulative dilution occurs that can ultimately be quite significant.

Which investors absorb that dilution depends largely on whether an investor has a pre-money or post-money SAFE. With post-money SAFEs, as SAFEs stack, it is typically the founders (and earlier investors) who absorb the dilution. For investors with pre-money SAFEs, their ownership can be impacted by dilution and SAFE stacking.

MFN Provisions in SAFEs

As an investor, are you remembering to use your MFN provision? These provisions offer early investors the opportunity to obtain terms that are more favorable to them if later SAFEs are issued that have a “lower cap or bigger discount,” according to JP Morgan. However, once a SAFE converts into stock, investors cannot take advantage of MFN protections — these protections must be used while SAFEs are being stacked.

Know What Your SAFE Actually Buys You

Startup founders often do well to think like an investor and to consider the lens from which different types of investors may approach fundraising efforts and options. Whether you are a startup founder seeking more information about SAFEs to attract investors, or you are considering investing in a startup that is offering SAFEs, one of the startup attorneys at Triumph Law can assist you. Contact our firm today to learn more about what investors should know about SAFEs and how to think through an investor’s lens when it comes to other methods of equity financing.

Sources:

jpmorgan.com/insights/business-planning/safe-notes-understanding-simple-agreement-for-future-equity