Creating a startup is an exciting time. You have the potential to bring a groundbreaking product into the world. But this isn’t an easy journey. One of the most common hurdles is a lack of funding. Though there are plenty of ways to overcome this challenge, many startups opt to bring an investor on board. These individuals have deep pockets and are willing to shell out big money to support businesses they believe in.
However, when your startup makes money, investors will want to take their cut. This is where a YC SAFE agreement can help. These provide security for investors, so they feel confident putting money into your startup. They also give flexibility to startup owners, so you can move at your own pace.
Let’s take a closer look at the YC form of SAFE so you can decide if it’s right for you.
How Does A YC SAFE Work?
A Simple Agreement for Future Equity (SAFE) is a fairly common way for startups to raise money from investors. It’s particularly common during the business’s early stages when you have yet to give away any equity or issue any shares. Under the YC form of SAFE, you take the investor’s money with a promise to give them shares later.
There are a few YC SAFE varieties out there, these are:
- Valuation cap SAFEs. This option sets the maximum price that the investor will pay for company shares. It doesn’t matter what the company valuation is when capital is being raised. If the company valuation rises to $20 million, but the valuation cap is $10, the investor converts their SAFE to equity at a value of $10 million.
- Discount SAFEs. This stipulates the discount that investors will get in the next round of funding. Typically, the discount offered is between 10 to 30 percent.
- Valuation and discount SAFEs. In this case, the investor gets offered both a valuation and a discount. When they redeem their SAFE for shares they get to choose which option they take.
- Most Favored Nation (MFN). This is the least common option. In this SAFE, the startup needs to offer investors the same terms they are using to attract funding in the next round of equity raising.
There are a few other elements that make YC SAFEs unique:
- There are no maturity dates and interest isn’t charged. This is what separates a SAFE from a typical convertible note.
- Can be done both pre and post-money. Both options allow investors to claim Series A shares. This flexibility allows startup founders quick access to funds when they most need it.
What Happens If The Company Sells Before The Equity Raising?
Some startup founders opt to sell their company, rather than go through the equity raising process. The good news is that a YC SAFE has provisions for these circumstances. Sometimes, they can use a 1× liquidation preference. This means that they receive the amount they initially invested. The other commonly used option is to convert the SAFE into shares, based on the company valuation, and then take their portion of the sale. As you would expect, investors choose the option that gives them the best return.
Benefits Of Choosing A SAFE
There are plenty of reasons why startups prefer to use a YC form of SAFE, these can include:
- Easier to negotiate. The interesting thing about SAFEs is that they all follow a standard agreement. This makes the negotiations easier for all parties involved. Generally, it’s best to use the same terms with all investors.
- Getting money faster. Because the negotiation process is easier, it should be easy to come to a deal that potential investors are happy with.
- Lower cost. Because the terms tend to be standard, it is easier for lawyers to process. Generally, these agreements are only five pages long. This reduces the amount of money you need to spend on legal costs.
Things To Be Careful About When Using A SAFE
Nothing is perfect. There are a few pitfalls to consider before you decide to use a YC SAFE, these include:
- Can risk dilution. Startup founders need to be strategic when using a YC SAFE. You don’t want to dilute your ownership stake too much. This is particularly common when you are doing multiple fundraising rounds with the YC form of SAFE. These agreements help protect investors from being diluted, so the additional equity tends to come from the founders. If you give away too much equity you can lose control of your company.
- Investors can lose everything. SAFEs don’t offer the same level of protection as shares, which is why investors get a higher return. The downside is that this requires an equity raising or company sale for investors to get paid. Sadly, not all startups get this far. If the venture fails, the investor might not be able to get their money back.
Conclusion
Investors can be a great source of funding for startups. The challenge can be finding an agreement that benefits both the startup founder and the investor. A YC form of SAFE might be the perfect way to overcome this issue and help your startup secure the support of wealthy backers.
