SAFEs Explained: Why SAFEs dominate pre-seed fundraising

Cody: Let's talk about pre-seed fundraising. What is the typical form of an early-stage financing for a startup company?

Nick: For pre-seed, most commonly you're going to see a SAFE. SAFE stands for Simple Agreement for Future Equity.

It was initially an instrument created by Y Combinator to make pre-seed fundraising really easy. It does that in a few different ways. One is that it's a very short, straightforward document. It's a handful of pages with about four variables: Equals the valuation, the discount if... The SAFE carries a discount to the next round in which it converts the name of the investor and the amount they're investing. The way it functions is as it sounds, a simple agreement for future equity. You're taking cash now and the instrument that converts into equity in the next priced round or in connection with the next price round that you raise. That allows you to take in money quickly, easily, cheaply and defer the longer form negotiation around stockholder rights and things like that to a later point. Because the investor is not a stockholder when they purchase the SAFE; they are a security holder, but not a stockholder with stockholder right and obligations. In a lot of ways it's very akin to a convertible note, but importantly different in a lot of ways. Do you see companies raising with convertible notes?

Cody: Often these days? Not as often anymore. I think there's a lot of good data out there that shows that for pre-seed financing, SAFEs are somewhere between 80 and 90 percent of those financing processes. The advantages of a SAFE really are that you don't need startup lawyers for the most part. I say that with some hesitation, but the form on the Y Combinator website truly is the form that you should use. There's a disclaimer there that says this form has not been modified, and there really has been market consensus that that agreement is good for both startup companies and investors.