Turning a business idea into a viable startup at the earliest stages of business development requires capital. The pre-seed funding round, which occurs before a priced financing round, provides early-stage startups with critical infusions of capital. Pre-seed funding often involves Simple Agreements for Future Equity (SAFEs).

Introduced by Y Combinator in 2013, the SAFE has become an important tool for raising capital from investors without the drawbacks of incurring debt such as ongoing interest payments. SAFEs are equity instruments. They provide investors with the right to receive equity in the company at a future date, which usually is the date that the company has a priced financing round. It is important to note that a SAFE does not provide investors with shares in the company at this stage. Once the company has a priced financing round, the SAFE investors are issued common stock or preferred stock. At that point, the investor becomes a stockholder in the company.

Most SAFEs have a valuation cap, which is the maximum valuation of the company that can be used for converting the SAFE into equity. The valuation cap can be pre-money or post-money valuation. This distinction impacts the dilution and ownership percentage ultimately received by the SAFE investor. A pre-money SAFE excludes the SAFE investment when calculating the company’s overall capitalization. In contrast, a post-money SAFE does take into account the SAFE investment when calculating the company’s capitalization. A post-money SAFE is considered more investor-friendly because it generally results in less dilution to investors.

If a SAFE is structured as a discount-only SAFE, it does not include a valuation cap. Under this structure, investors receive the benefit of converting their SAFE investment into equity at a discount to the price paid by investors in the company’s next priced equity financing round. This provides flexibility for early-stage startups that have limited operating history and may not yet be in a position to establish or imply a company valuation. Investors in a discount-only SAFE will receive a fixed percentage discount (such as a 10% discount) on the share price in the next priced equity financing round.

Some SAFEs have a most-favored nations (MFN) provision in lieu of valuation cap or discount. The MFN provision protects early investors if the company provides subsequent SAFE investors with better terms. Pursuant to the MFN provision, the early investors are also entitled to receive the upgraded SAFE terms.

The SAFE is offered and sold in reliance on exemptions from U.S. securities law registration. Specifically, the SAFE relies on exemptions from registration under Section 4(a)(2) of the Securities Act of 1933 and Rule 506(b) of Regulation D.

Y Combinator’s website includes templates for drafting SAFE documents for both U.S. and non-U.S. companies. The SAFE documents are relatively streamlined contracts that outline the essential terms, representations, and risk factors.

SAFE investors often negotiate for pro rata rights. This provides investors with the ability to purchase additional equity in the company in future financing rounds in order to maintain their

ownership percentage in the company. Investors often get these pro rata rights in a separate Side letter.