Back in 2013, the Y Combinator ("YC"), a top Silicon Valley Seed Accelerator, introduced the Simple Agreement for Future Equity ("SAFE"), which has been widely used by startups and investors all over the world for early stage fundraising.
What is a SAFE? It's a financial instrument that simplifies Seed investment by serving as a right to purchase shares in a future priced round, subject to certain parameters set in advance. The SAFE does not have a maturity date nor an interest (profit) rate, as it is neither a debt nor equity. It should be simpler, quicker and cheaper than the priced equity round.
Due to the wide acceptance of the SAFE, startups started to raise more SAFE rounds as each independent round (as opposed to using it as a "bridge round"). This made it difficult for the founders and investors to keep track of their relative ownerships (ex. SAFE rounds dilute each other). YC, conscious of the voice raised by the startup ecosystem, introduced the new Post-Money Valuation Cap SAFE in late-2018 ("Post-Money SAFE").
Here are three reasons why, at Shorooq Partners, we have decided to adopt the Post-Money SAFE for our early stage investments.
Clear tracking of ownership and dilution
The Post-Money SAFE, as its name implies, works with a post-money valuation, which is the valuation immediately after (1) all of the SAFE investments until the priced equity round (commonly Series A in the region); (2) the option pool created or increased as part of the SAFE rounds (but prior to the equity financing).
Given the Post-Money Valuation Cap, the SAFEs are NO longer diluted by each other nor by the options granted or created from the subsequent SAFE rounds (but prior to an equity financing). Therefore, investors and founders can accurately track ownership and dilution changes they will get with their investment. For example, $1mm Seed raise at the Post-Money Valuation Cap of $5mm would give 20% ownership to the Seed SAFE investors regardless to the startup raising another SAFE round(s) in a future date, only to be diluted by the Series A.
In the Pre-Money SAFE, pro-rata rights are a default component - these rights are held by SAFE investors to participate in a subsequent round to maintain their percentage ownership, and are applied to the financing after the round in which the SAFE converted to shares (or at least this was the original intention yet we apply this differently in the Middle East as it has become a norm to invest pro-rata before the SAFE conversion into shares).
In the Post-Money SAFE, pro-rata rights are no longer included as default and must be affirmatively granted to the investor, by entering into a standardized side letter that grants such rights and applies to the round in which the SAFE converts. In the writer's perspective, despite the extra work to create the side letter, it is benefit to the founders as they can decide which strategic investors to give the pro-rata rights vs. everyone.
The Pre-Money SAFE can only be amended under the written consent of the investor, whereas the Post-Money SAFE can be amended upon majority of SAFE holders' consent. This change allows the founders and the investors to amend the SAFE for all SAFE holders in a more practical and functional manner.
There are several other reasons that make the Post-Money SAFE an essential financing security for both founders and investors and Shorooq believes that this will further accelerate the current explosive growth of the startup ecosystem in UAE, Middle East and beyond. We are excited to be a key driving force behind this progressive initiative and are happy to share our thoughts regarding when and how to use the Post-Money SAFE.
- Shane Shin is a managing partner, Shorooq Partners and Wendy Sfeir is a Legal Counsel, Shorooq Partners. Views expressed here are their own and do not reflect newspaper's policy.