Angel investor: “Sure, I’ll invest in your startup! I love what you all are doing and really believe in the potential of your business!”
Founder: “Great, let’s move forwards!”
Angel Investor: “Sounds good, so do we need to sign a contract or something?”
Founder: “Yeah, I guess so. Do you know what sort of contract we should use?”
Angel Investor: “No, I thought you would. OK, let’s do some research and reconnect next week.”
Founder (to themselves): “Shit! Why didn’t I have a document ready to go? Now we’re delayed and who knows what might happen…”
Angel Investor (to themselves): “Hmm, I thought they’d be better prepared for this situation… Am I the only one investing? If they’re unprepared for this am I really confident they can scale a business?”
When founders start raising money for their first funding rounds many aren’t sure what documentation to use. Often their investors aren’t sure how to proceed either. This can cause the round to take longer than necessary or even fall apart. At Accelerating Asia we use something called a SAFE note to invest in the startups admitted to our accelerator.
SAFE stands for Simple Agreement for Future Equity. A SAFE is similar to a warrant, it's an option to buy equity later at the terms defined in the agreement. SAFEs were pioneered by the Ycombinator in 2013 as an alternative to convertible debt, which was widely used at the time. Compared to convertible notes or priced equity, SAFEs are typically a faster and lower-cost way to facilitate investment and are thus attractive to startups, Angels and some Venture Capital firms. In 2019, Angelist released data showing that 80 percent of funding rounds on their platform with investment amounts of US$20 million or below were made using SAFEs. In Singapore and Southeast Asia the number is lower, but continues to grow.
At Accelerating Asia we only use SAFEs for startup investment and almost all of the non-institutional investment raised by our founders use SAFEs as well.
Before we get into the details, there are a few terms in most SAFEs that you should be familiar with:
SAFEs are relatively short documents, do not require filing with a regulator or government and can be due diligenced quickly.
The startup valuation when using a SAFE is usually variable and will be determined when the SAFE converts to equity in a later financing round.
The founders and investor agree on a formula that will determine the valuation that the investment from the investor comes in at depending on a future fundraising round (usually by an institutional investor). This essentially punts the duty of determining the startup's valuation to the next round, when an institutional investor who usually has more resources and data to determine the proper market rate for the business is involved.
Let’s assume an Angel investor decides to invest $100,000 in an early stage startup at the following terms:
Qualifying Round $500,000
Now let’s assume a Venture Capital fund decides to invest in the startup one year later at the following terms:
How does this new round with the VC fund affect the angel investor with the SAFE note?
First, we need to see if the investment amount is large enough to trigger the SAFE conversion. The minimum raise needed to trigger the SAFE conversion is $500,000 and the investment amount for the new round is $1,000,000 so the SAFE is triggered.
In order to determine the valuation that will be applied to the SAFE note investment, we need to determine whether the cap or the discount will be used (it is not standard practice to use both).
Next, we apply the discount to the new investment valuation, which in this case is $5,000,000 * (1-.2) = $4,000,000. Is this number lower than the valuation cap of the SAFE? $4,000,000 is larger than the cap of $2,000,000 so the answer is no. Therefore, the cap will be used to convert the SAFE into equity shares. Had the discounted valuation been lower than the cap that number would have been used and not the cap.
OK, so now we have a valuation for the SAFE ($2,000,000) and we simply divide that number by the investment amount to determine the ownership the investor receives as a result of the investment in the SAFE. In this case it is $100,000/$2,000,000 = 5%
Now, the amount the investor actually receives will be diluted by the new investment and this article isn’t the place to dig into such calculations, but if you’re curious you can read this.*
As mentioned previously, SAFEs are typically shorter and simpler documents that can be executed between the parties without much due diligence, legal expense or registration with government or regulators. They are just as enforceable as priced equity in most but not all jurisdictions so do your research.
Investors are not required to attend shareholder meetings or sign off on the company's decisions, freeing up the investor’s time and helping the company move faster with less bureaucracy, which is a big advantage for an early-stage startups with limited resources. Funds can be raised quickly, with verbal agreement to money in the bank sometimes happening in days.
In summary, it’s a fast and cheaper way to invest and creates less responsibility for each party to the agreement. When the SAFE converts to equity the investor then becomes a shareholder at the terms of the new investment.
At Accelerating Asia we believe SAFEs are usually the right investment vehicle to use for early-stage startup investment, but they aren’t for everyone.
Some investors dislike SAFEs because they wish to become shareholders from day one, have more control in the startup than a SAFE typically provides or feel like a SAFE is a less secure investment.
Another risk is that founders who raise multiple rounds using SAFEs may lose track of the future equity they are giving away and be surprised at the dilution when the SAFEs are triggered later on. There are plenty of calculators available online to track such things but it does happen. Other investors find the cap and discount formula a bit complicated and prefer to determine a number for valuation straight away and become a shareholder through a priced-equity round.
The world’s most prominent startup ecosystem, Silicon Valley, has chosen SAFEs to be the de facto document to use for early-stage startup investment as they are more streamlined, cheaper to execute, and easier to due diligence than other options.
At Accelerating Asia we agree and also use SAFEs for our own startup investments and we also facilitate other investments in our portfolio companies through SAFEs. We believe that SAFEs are a benefit to both founders and investors and to the startup ecosystem generally and help “grease the wheels” of startup investment, enabling more startups to get funded and more potential investors - usually Angels - to feel comfortable making startup investments. However, no document is a best fit for every situation and both founders and investors should consider all options before moving forwards on an investment round.
*For the sake of easier calculations I’m using “post-money” numbers.
If you’re interested in investing along side us, meeting our portfolio companies or just generally interested in talking to us about startup investing, please reach out to us via email.
Craig Bristol Dixon is Co-Founder of Accelerating Asia and General Partner Accelerating Asia Ventures. He has been involved in 50+ investment rounds in startups as either a founder, institutional investor or Angel investor.
Accelerating Asia invests in startups with scalable technology solutions and revenue generating business models that combine purpose with profit.
In making an investment decision, investors must rely on their own examination of startups and the terms of the investment including the merits and risks involved. Prospective investors should not construe this content as legal, tax, investment, financial or accounting advice.