SAFE (Simple Agreement for Future Equity)

A Simple Agreement for Future Equity (SAFE) is a financing instrument that was developed to offer start-ups a simpler and more flexible way of raising capital. It is an agreement between an investor and a start-up company in which the investor provides a certain amount of money in return for the right to receive equity (shares) in the company in the event of a future event. The special feature of SAFE is that neither a company valuation nor a fixed price for the future shares is determined at the time of the investment. Instead, the exact conditions are only determined when certain events occur, such as a later financing round or a company sale.

Origin and development

SAFEs were developed in 2013 by the US startup accelerator Y Combinator to create an alternative to conventional convertible loans. Since then, they have become a popular financing instrument for early-stage start-ups in the US and are also increasingly being used in Europe, including Germany.

How does a SAFE work?

1. investment: The investor provides the startup with an agreed amount of money. 2. no immediate consideration: In contrast to a direct equity investment, the investor does not initially receive any shares in the company. 3. conversion event: The agreement defines certain events upon the occurrence of which the invested amount is converted into equity. Typical conversion events are:
– A qualified financing round (e.g. Series A)
– A company sale (exit)
– An initial public offering (IPO) 4. Conversion into equity: When a conversion event occurs, the invested amount is converted into company shares. The number of shares is calculated based on the agreed conditions (e.g. valuation cap or discount).

Central elements of a SAFE

– Valuation cap: A maximum company valuation used to calculate the number of shares in the conversion. – Discount: A percentage discount on the price per share paid by investors in the next round of financing. – Most Favored Nation (MFN) clause: Guarantees the investor the best terms if the startup later issues SAFEs with more favorable terms. – Pro-rata rights: Gives the investor the right to participate in future financing rounds to maintain their percentage stake in the company.

Advantages of SAFEs

1. simplicity and flexibility: SAFEs are generally shorter and less complex than traditional financing documents. 2. faster negotiations: Since no immediate business valuation is required, negotiations can be expedited. 3. cost effective: lower legal and administrative costs compared to traditional financing rounds. 4. no interest or maturity date: unlike convertible loans, there is no interest and no fixed repayment date. 5. attractive for investors: Valuation caps and discounts allow investors to benefit from a potential increase in the value of the startup.

Challenges and risks

1. legal uncertainties: In Germany, the legal classification of SAFEs has not yet been conclusively clarified, particularly with regard to corporate law and tax aspects. 2. dilution risk: For founders, there is a risk of greater dilution of their shares if several SAFEs are issued. 3. complexity with several SAFEs: The calculation of the share distribution can become complex if there are several SAFEs with different conditions. 4. lack of participation rights: SAFE investors usually have no voting rights or other typical shareholder rights until a conversion to equity takes place.

Legal and tax aspects in Germany

Some adjustments and considerations are necessary when using SAFEs in Germany: 1. classification under company law: SAFEs should be structured as agreements under the law of obligations with option rights or preliminary agreements. 2. tax treatment: The tax classification of SAFEs has not yet been conclusively clarified. It is advisable to obtain binding information from the tax authorities. 3. notarization: Depending on the structure, notarization may be required. 4. subordination: A qualified subordination should be agreed to avoid balance sheet over-indebtedness. 5. capital increase: The conversion into equity should be structured as a cash capital increase with contribution of the SAFE claim to the capital reserve.

Conclusion

SAFEs offer an innovative and flexible option for startup financing that is particularly suitable for very early stages. They simplify the financing process and can be attractive for both sides – startups and investors. However, their use in Germany requires careful legal and tax structuring. As SAFEs become more widespread, it is to be expected that market standards and best practices for their use will also emerge in Germany. It is important for start-ups and investors to carefully weigh up the advantages and disadvantages of SAFEs and, if necessary, seek professional advice to ensure an optimal and legally compliant structure.