{"id":585,"date":"2021-01-04T22:41:34","date_gmt":"2021-01-04T22:41:34","guid":{"rendered":"http:\/\/wutif.ca\/?p=585"},"modified":"2026-03-02T18:25:51","modified_gmt":"2026-03-02T18:25:51","slug":"safes-arent-what-theyre-cracked-up-to-be","status":"publish","type":"post","link":"https:\/\/wutif.ca\/index.php\/2021\/01\/04\/safes-arent-what-theyre-cracked-up-to-be\/","title":{"rendered":"SAFE’s Aren’t What They’re Cracked Up to Be"},"content":{"rendered":"

A SAFE \u2013 Simple Agreement for Future Equity \u2013 was created by Y-Combinator in Silicon Valley as a way for companies to raise a small amount of capital as a first step towards raising a larger venture capital round. While it may make sense if a VC round is assured, there may be a better way using a \u201cSAFETY\u201d.<\/p>\n

What is a SAFE?<\/strong><\/p>\n

A SAFE is a way for investors to put capital into a company\u2019s pre-seed (<$2M) or seed round (>$2M) without having to specify the valuation or type of shares (common or preferred). Basically, cash is advanced, but shares are issued at a later date \u2013 usually at the time of a more substantial investment round (e.g. Series A, >$5M). Founders like it because they may end up with a higher valuation. Investors generally prefer low-valuation priced rounds but may go along with a SAFE because it gives them a discount to a later round for their risk – albeit much riskier. A great deal of trust<\/span> is required on the part of the investor. There have been stories of companies getting funded by a SAFE and then absconding with the cash.<\/p>\n

The Problem with SAFEs<\/strong><\/p>\n

With a SAFE, investors are in a precarious position because they have no voting rights and do not have the usual investor protections (eg SHAG, Pref class, etc). There are also issues around trigger points, uncertainty around conversion, and time limits. Another real concern is that a SAFE does not count as equity for tax purposes (e.g. Cap Gains treatment, especially the life time exemption). Some lawyers have opined that SAFEs count as equity but if there’s a repayment provision that could be interpreted as a debt obligation, I doubt that CRA would call it equity (no CRA ruling on this yet).<\/p>\n

With a SAFE, investors are more like lenders \u2013 not real equity investors and can get stuck in a grey area. For example, what happens if the company doesn\u2019t do (or need to do) a subsequent (eg Series A) round? What happens if there\u2019s an early exit? What happens if a Series A takes longer than expected? What rights (eg voting) do SAFE investors have? What prevents a company from diluting SAFE investors by doing many small rounds? What reporting rights do investors have? Who determines governance? What stops a founder from misappropriating funds? The questions go on….and on.<\/p>\n

A standard term of a safe is the 20% discount that investors get when they convert their SAFE to shares. Considering the unsecured risk to the investor, this discount should be double that. Why investors accept 20% is a mystery.<\/p>\n

Because of the risks to investors, FINRA and the SEC have posted cautions:
\nhttps:\/\/www.sec.gov\/oiea\/investor-alerts-and-bulletins\/ib_safes<\/a><\/p>\n

FINRA says: “Note a Debt, Not Equity” – FINRA\u2019s primary guidance (reiterated in their 2026 Regulatory Oversight reports) is that a SAFE is a deferred equity investment<\/b> and that investors may never get their money back or get shares.<\/p>\n

If a deal is too good to miss and you can’t get the company to consider a SAFETY (see below), for a thoughtful discussion of pre and post money SAFEs, check out:
\nhttps:\/\/cytlaw.medium.com\/post-money-safe-math-problems-3f9afca5be61<\/a><\/p>\n

Bottom line: investors are nobody! It means that investors must implicitly trust the entrepreneur. And that’s what it comes down to. Why it works in accelerators (like Y-C) is because there are relationships – and a level of trust – that have been built over time.<\/p>\n

The Solution: a SAFETY<\/strong><\/p>\n

A SAFETY \u2013 Simple Agreement -with shares – for Future Equity Today \u2013 accomplishes the same end purpose but gives the investor real equity (common or pref shares) with an agreement to adjust the number & class of shares of the SAFETY to those of the Series A. (BTW \u2013 SAFETY is just a word I made up for fun. In reality it is just a clause<\/span> that would be added to a subscription agreement -see below).<\/p>\n

Unlike a SAFE,\u00a0 a SAFETY is really just a right attached to the common or preferred shares that are being offered on a seed round.<\/p>\n

Implementation<\/strong><\/p>\n

SAFE TERMS<\/u>\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0SAFETY TERMS<\/u><\/p>\n

Purchase Amount\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 =\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Subscription Amount
\nDiscount Rate\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 =\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Bonus Shares
\nValuation Cap\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 =\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Pre-Money Price per share<\/p>\n

Example<\/strong><\/p>\n

SAFE: A Company wants to do a SAFE to raise $500K (the aggregate Purchase Amount) with a pre-money valuation cap of $8M, a Discount Rate of 20% and a conversion trigger of $1M. This means that when the Company raises $1M or more on a Series A, the SAFE investors will get the class of shares to be issued at a per-share price that is the lower of the Valuation Cap or 80% of the Series A pre-money Valuation (per share). The Purchase Amount will convert under these terms.<\/p>\n

SAFETY: The Company issues $500K in common shares at a pre-money valuation equal to the Valuation Cap. If, and when, the Company raises $1M or more on a Series-A and if the discounted valuation is lower than the Valuation Cap, the SAFETY investors will be topped up with Bonus Shares such that they end up with the same number of shares that they\u2019d have if they had purchased a SAFE. If the Series-A issue is for a preferred class, their common shares would be exchanged for the same class with the same terms of that class.<\/p>\n

SAFETY Agreement
\n<\/strong><\/p>\n

Whereas a SAFE is a documented stand-alone agreement, the SAFETY is just a paragraph or two that would be added to a subscription agreement. For example, it could be the first part of a normal share subscription agreement as copied below. The added SAFETY wording is italicized<\/em>.<\/p>\n

[SAMPLE] SUBSCRIPTION AGREEMENT<\/strong><\/p>\n

The undersigned (referred to herein as the \u201cPurchaser<\/strong>\u201d), hereby irrevocably subscribes to purchase from ABC Inc. (the \u201cCompany<\/strong>\u201d) the number of Common shares in the capital of the Company (a \u201cPurchased Securities<\/strong>\u201d) at the price of $0.75 per share.<\/p>\n

This subscription, the attached terms and conditions (the \u201cTerms and Conditions<\/strong>\u201d), a completed and executed Subscriber Certificate (as defined in the Terms and Conditions) and the appendices attached hereto and thereto are collectively referred to as the \u201cSubscription Agreement<\/strong>\u201d. The Purchaser agrees to be bound by the Terms and Conditions and agrees that the Company may rely upon the covenants, representations and warranties contained in the Subscription Agreement.<\/p>\n

[In this section, the number of shares and amount is stated along with the Purchaser\u2019s address and share registration instructions.]<\/p>\n

SUBSCRIPTION AGREEMENT \u2013 Terms & Conditions<\/strong><\/p>\n

    \n
  1. The Securities
    \n<\/strong>1.1\u00a0<\/strong>The Purchased Securities will be registered in the name of the Purchaser.
    \n1.2<\/strong>\u00a0The Purchaser shall have the right to exchange the Purchased Securities into such number of the class or series of shares issued by the Company (the \u201cNext Round Shares<\/strong>\u201d) in a transaction or series of related transactions with the principal purpose of raising capital pursuant to which the Company issues and sells Next Round Shares for aggregate gross subscription proceeds of at least *$1,000,000 (excluding conversion of convertible instruments) (an \u201cEquity Financing<\/strong>\u201d) equal to the Aggregate Subscription Amount divided by the Conversion Price (the \u201cShare Exchange Right<\/strong>\u201d).
    \n[* this is the amount that shows in a SAFE as the conversion trigger amount \u2013 e.g. the amount raised on the Series A.]
    \n<\/em><\/li>\n<\/ol>\n

    For purposes herein,<\/p>\n

    i. \u201cCompany Capitalization<\/strong>\u201d means all shares in the capital of the Company issued and outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants, and other convertible securities\u00a0and<\/u>\u00a0(2) all shares reserved and available for future grant under any equity incentive or similar plan of the Company;<\/p>\n

    ii. \u201cConversion Price<\/strong>\u201d means the lower of: (1) the price per share equal to the Specified Amount; or (2) *80% of the price per Next Round Shares sold in the Equity Financing; [*this is equal to 1 minus the discount as would be specified in a SAFE.]
    \n<\/em><\/p>\n

    iii. \u201cSpecified Amount<\/strong>\u201d means the Valuation Cap divided by the applicable Company Capitalization;<\/em><\/p>\n

    iv. \u201cValuation Cap<\/strong>\u201d means the Company\u2019s pre-money valuation of CAD$8,000,000;<\/em><\/p>\n

    1.3\u00a0In connection with the Share Exchange Right, the Company and the Purchaser hereby agree that:<\/em><\/p>\n

    (a) in respect of issuance of any Next Round Shares to the Purchaser pursuant to an Equity Financing, the Purchaser shall execute and deliver to the Company all transaction documents related to such Equity Financing, provided that such documents are the same documents to be entered into with the purchasers in the Equity Financing;<\/em><\/p>\n

    (b) the Company shall provide the Purchaser with a ten (10) days advance notice of the Equity Financing and provide the Purchaser with such information as may be reasonably required by the Purchaser to make an election as to whether to exercise the Share Exchange Right; and<\/em><\/p>\n

    (c) the Purchaser shall have the right to exercise the Share Exchange Right fully as to all of the Purchased Securities or partially as to a portion of the Purchased Securities.<\/em><\/p>\n

    [The rest of the document is the Company\u2019s normal share subscription agreement that contains the usual boilerplate wording regarding acceptance, closing, securities exemptions, reps and warranties, etc, etc.]<\/p>\n

    Bottom Line: SAFEs make already risky investments even more risky!<\/p>\n","protected":false},"excerpt":{"rendered":"

    A SAFE \u2013 Simple Agreement for Future Equity \u2013 was created by Y-Combinator in Silicon Valley as a way for companies to raise a small amount of capital as a first step towards raising a larger venture capital round. While it may make sense if a VC round is assured, there may be a better … <\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/posts\/585"}],"collection":[{"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/comments?post=585"}],"version-history":[{"count":10,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/posts\/585\/revisions"}],"predecessor-version":[{"id":1457,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/posts\/585\/revisions\/1457"}],"wp:attachment":[{"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/media?parent=585"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/categories?post=585"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/wutif.ca\/index.php\/wp-json\/wp\/v2\/tags?post=585"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}