For founders launching a first fundraising round, SAFEs (Simple Agreements for Future Equity) are a popular and flexible option to bring in early capital without the complexities of carrying out a traditional priced financing round. A SAFE round allows founders to quickly access capital while deferring the need to set a precise company valuation until a later date, typically when the next fundraising round happens. In this post, we’ll recap the fundamentals of how SAFEs work, as well as explain how they convert, how they protect investors, and the strategic considerations founders should keep in mind when planning a SAFE round.

What is a SAFE, and How Does It Work?

As discussed in an earlier Bowery article, a SAFE is essentially an agreement that provides investors with the right to receive a certain number of shares in a company during a future equity financing round, such as a Series Seed, or at another conversion event like a sale of the company, change of control or initial public offering. SAFEs are often preferred by early-stage startups because they offer a simpler structure than traditional convertible notes (as SAFEs do not accrue interest or have a maturity date) and rarely entail the significant investment of time and money required by a full-fledged priced financing. Here’s how SAFEs work in practical terms:

  • Conversion Mechanics: SAFEs convert into equity at a triggering event, usually the next priced financing round. The number of shares a SAFE holder ultimately receives depends on a number of variables, including the company’s valuation at the time of conversion, the valuation cap and/or discount rate applied to the SAFE, and whether the SAFE is calculated on a “pre-money” or “post-money” basis.
  • Investor Protections: Although SAFEs typically don’t provide voting rights, dividends, or board seats, they do have mechanisms to protect investors. If the company undergoes a liquidity event (like a sale or merger) or dissolution event while the SAFE remains outstanding, the SAFE investor typically gets paid out (either in the form of cash or equity, depending on the event triggering the conversion) an amount equal to their original investment or some other amount depending on the terms and economics of the SAFE.

Key Terms to Know: The Valuation Cap

A primary component of a SAFE is the valuation cap, which effectively puts a ceiling on the price at which the SAFE converts into equity, regardless of the valuation set in the next funding round. The cap ensures that early investors receive shares at a more favorable price than later investors, assuming the company’s valuation increases beyond the SAFE’s cap come the time of the priced round. The remainder of this article proceeds under that assumption – i.e., that the valuation cap of the SAFE in question is lower than the company valuation at the time of the priced financing round during which the SAFE converts.

Valuation caps can be calculated on a pre-money or post-money basis. Before one can understand the difference between the two, we need to understand how SAFEs convert into equity. In short, proceeding under the assumption stated above, SAFEs convert at a lower price per share (PPS) than that being offered in the applicable priced financing round. The SAFE PPS is calculated by taking the SAFE valuation cap and dividing that by the total capitalization of the company. In all cases, that capitalization denominator will include all currently outstanding shares of the company plus all outstanding options. (Note: investors may try to include other items when calculating capitalization, like promised options or the shares in the company’s stock plan, to try and drive that PPS even lower).

This brings us back to the difference between pre-money and post-money SAFEs. Post-money SAFEs include all outstanding convertible securities (including this SAFE and all others) in the definition of company capitalization. Pre-money SAFEs do not. The math illustrating the difference between the two can be a bit tricky, especially when it comes to pre-money SAFEs, but the important thing to know is that post-money SAFEs will always result in a percentage of the company equal to a minimum of:

SAFE Investment Amount ÷ Post-Money Valuation Cap

Thus, if an investor purchases a $1 million SAFE with a $10 million post-money valuation cap, they will own 10% of the company upon conversion of the SAFE. Since the SAFE itself and all other SAFEs are already factored into calculating the conversion PPS, the investor knows for certain that it won’t be subject to additional dilution at the time of the priced round.

For this reason, the post-money valuation cap is the preferred SAFE structure for investors and has become the clear standard in SAFE financings.

What is a Standard Valuation Cap for a First Fundraising Round?

For early-stage fundraising rounds, especially for companies that are pre-revenue or at the MVP stage, the market standard for a valuation cap generally falls between $7 million and $10 million – though naturally, this range represents a general average and is by no means represents a hard and fast rule. As with everything, context is key, and your mileage may vary depending on your company’s unique situation. That said, we generally find this range to be ideal for providing early investors with the upside potential they’re looking for while keeping dilution manageable for founders.

Keep in mind, if there isn’t a lead or sophisticated institutional investor in the round—for instance, if you are primarily raising through friends and family—the founders might consider offering no valuation cap. Instead, they can simply offer a discount, typically around 10% to 20%, sometimes even pairing that with a most-favored-nation (MFN) clause. This approach allows founders to reward friends and family for taking an early risk by offering a valuable discount – and with the MFN, also giving these early investors the option to match any later SAFEs issued with more favorable terms (such as a valuation cap or higher discount). This can be favorable in the event founders are uncomfortable setting, or simply prefer not to set, a precedent for valuation at this early stage in the company.

How Much Should You Sell in a SAFE Round?

In determining the amount to raise in a SAFE round, founders should carefully consider the overall dilution impact. We typically advise capping a SAFE round at about 15% of the company’s total equity. Keeping the SAFE round at or below this threshold helps preserve founder ownership and minimizes dilution, leaving enough equity on the table for future investors in subsequent rounds.

Key Considerations Before Launching Your SAFE Round

  • Think Ahead to Future Rounds: When setting terms, it’s important to remember that the SAFE round will impact future financings. A high level of dilution at this stage could make it harder to bring in larger investors at a favorable valuation down the line.
  • Align on the Cap: Be strategic about setting a realistic valuation cap that reflects your company’s stage and potential but still offers a meaningful upside to investors. A market-standard range of $7 million to $10 million is common for a first round, but do adjust based on your unique positioning and investor interest. Founders should keep in mind that the higher the cap the parties agree on, even beyond $10 million, the better it is for them, as this will lead to a higher price per share at the time of conversion.
  • Remain Consistent: Aim to minimize the number of SAFE variations offered, ideally sticking to no more than two or three different terms. For instance, if you have three different SAFEs, each ultimately converting at a different PPS, by law those will each have to convert into their own series of preferred stock, which can quickly complicate your cap table, making it harder to manage and track ownership. A clean and streamlined approach here not only makes your cap table more appealing to future investors but also helps maintain a consistent valuation framework across stakeholders.

In Summary

Approaching a SAFE financing round can be a highly effective strategy for early-stage startups, allowing you to access capital efficiently and defer setting a definitive company valuation. Founders should understand how SAFEs convert, how they protect investors, and the variety of terms found in a SAFE, like valuation caps and discounts, and the implications thereof. By setting a clear and realistic cap, staying within the dilution threshold, and thoughtfully planning for future financing, you’ll be better positioned to launch a successful SAFE round that aligns with your company’s growth trajectory.

At Bowery Legal, we specialize in helping startups from day one, including guiding them through their SAFE financings. If you need assistance, or have any questions on this topic, don’t hesitate to reach out to our team!