SAFEs explained: how startups raise before a priced round, and why they need a corporation

Most US startups raise their first money on a SAFE, a Simple Agreement for Future Equity. It's a short document, published by Y Combinator and used largely unchanged by most investors: the investor pays now and gets shares later, at the company's next priced round. It isn't debt and it isn't stock, and it assumes a corporation with shares to issue, which is why founders who plan to raise form a Delaware C-Corporation.

Say an investor pays $100,000. The SAFE doesn't say how many shares that buys, because the company hasn't been valued yet. When the company raises a priced round, where investors pay a set price per share, the SAFE converts into shares at that round's price, adjusted by whichever of two terms you agreed:

• A valuation cap: the SAFE converts as if the company were worth no more than the cap, so an early investor gets a better price than the new investors if the company has grown.
• A discount: the SAFE converts at the round's price minus a percentage, commonly 10% to 20%.

Y Combinator's post-money forms use one or the other, not both. A third has neither: it converts at the round's price, with a most-favoured-nation clause that lets the holder take the better terms of any later SAFE.

Since 2018, the standard form has been the post-money SAFE, where the cap is a post-money valuation, so each SAFE's ownership can be worked out when it's signed: $100,000 on a $5 million post-money cap is 2% of the company, before the round that converts it. Founders can see how much they're giving away SAFE by SAFE, which was the point of the change. Y Combinator publishes the forms, along with a side letter for pro rata rights, and versions for companies in Canada, the Cayman Islands and Singapore.

A SAFE converts into stock. An LLC has membership interests, not shares, with no board to approve an issue and no authorised share count, and its tax treatment doesn't fit how the SAFE is designed. Investors who want to use a SAFE will usually ask an LLC to convert to a Delaware corporation first, at the founder's expense. It's one of the most common reasons founders abroad form a C-Corporation instead of an LLC.

• Stacking. Several SAFEs with low caps can add up to more of the company than each looked like on its own. Add them up before you sign the next one.
• Board approval. The board should approve each SAFE, and each should be recorded on the cap table. Investors will read both.
• Securities law. A SAFE is a security. Sales to US investors rely on an exemption, often Regulation D, with a Form D filed with the SEC within 15 days of the first sale. Filing it is free, and sales to investors in your own country may have rules of their own.
• Your own country's view. A US corporation raising money is still your company for your home country's tax purposes, so ask an adviser before the first money arrives.