Starting a venture is never really an easy call, and Chike’s situation was no exception.

His idea would revolutionise the African agri-tech sector, but capital could be an hinderance.

 

Knowing how fragile start-ups can be at negotiating, combined with the economic climate; traditional funding was at best a last resort. In the local lingua, he was going to ‘raise money on the street’. However, to navigate this less structured, flexible but delicate means of access to capital, it was a no-brainer to go by way of a Simple Agreement for Future Equity (‘SAFE’).

 

But then he needed to tackle the big question – “Is it really safe to do a SAFE?”

 

It is well understood that SAFE is a contract between an investor and a startup that grants the investor the right to equity at a later date. This is usually during a subsequent funding round or upon a triggering event. Unlike traditional equity investments, SAFEs don’t assign a specific share price at the time of the initial investment. Instead, they convert to equity later based on predetermined terms.

 

However, is there any uncertainty about the share price at the point of investment that can make both investors and business owners wary? Or is it really all rosy to the end?

 

Well, it is only fair that we break it down to enable Chike get the pros and cons from the different sides of the divide.

 

Advantages of a SAFE for Startups

 

1. Simplicity and Speed

For startups, like Chike’s, one of the primary benefits of SAFEs is their simplicity. Traditional funding rounds can be time-consuming often involving complex negotiations and hefty legal fees. SAFEs streamline this process, allowing startups to raise money quickly and focus on growing their business. Chike will be able to secure funding swiftly, giving him the runway he needed to develop his product.

 

2. Deferred Valuation

Using a SAFE will allow Chike delay valuation discussions until a later funding round. This is advantageous because his early-stage company will have the proper metric to arrive at a proper valuation. As his startup grows and gains traction, the valuation will increase significantly, benefiting both Chike and his early investors.

 

3. Flexibility

SAFEs offer flexibility in structuring the agreement. Chike can set terms that attract the right investors while maintaining control over his company. This included deciding on caps, discounts, and other conversion terms that will be beneficial to both parties. He will be able to tailor the SAFE to suit his unique needs and those of his investors.

 

Advantages for Investors

 

1. Early Access to High-Potential Investments

Investors using SAFEs can gain early access to startups with high growth potential. This can be a significant advantage if the company becomes successful, as the SAFE can convert into equity at a favourable rate. Chike’s early investors will be able to secure a stake in his promising startup before it skyrocketed in value.

 

2. Simplified Investment Process

Traditional equity investments require detailed negotiations and due diligence. SAFEs reduce this complexity and cost, eliminating the need for extensive due diligence and lengthy negotiations. This will make it easier for Chike’s investors to support multiple startups, spreading their risk and potential rewards.

 

3. Protection in Future Rounds

Many SAFEs include terms that protect investors in future funding rounds. For example, valuation caps and discounts will ensure that Chike’s early investors receive a fair and favourable conversion rate when the SAFE converts to equity. This protection will give them confidence in their investment.

 

Potential Risks and Considerations

While SAFEs offer many benefits, they also come with risks and considerations that both business owners and investors should be aware of.

 

1. Uncertain Outcomes

One of the primary risks for investors is the uncertainty surrounding the eventual conversion to equity. Since the valuation is determined at a future funding round or triggering event, there’s a risk that the terms might not be as favourable as anticipated. This uncertainty can make it challenging to assess the true value of the investment upfront, unless the parties use a Post-money SAFE or negotiate a valuation cap.

 

2. Dilution Concerns

For founders, using SAFEs can lead to significant dilution of their ownership if not carefully managed. As more SAFEs convert into equity during subsequent funding rounds, the ownership percentage of the founders can decrease. Chike has to carefully consider the amount and terms of SAFEs he issued to avoid excessive dilution.

 

3. Lack of Immediate Control

Unlike traditional equity investments, SAFEs do not provide investors with immediate ownership or control. This can be a drawback for investors looking for more immediate participation or control in the business.

 

4. Regulatory and Legal Considerations

A SAFE is a security document that may trigger violations of rules against public offers of securities if the funding process is not properly managed. To manage this risk, Chike needs to ensure all terms will be in compliance with securities laws.  Both parties should be aware of the legal and regulatory implications of SAFEs and understand the legal limitations of using SAFEs.

 

Conclusion

For startups, SAFEs offer a quick and flexible way to raise early-stage capital without the immediate pressure of a valuation, as seen in Chike’s case. This allows businesses to grow and validate their models efficiently.

 

For investors, SAFEs provide an easy entry into promising startups with potential high returns. However, the lack of immediate equity and the uncertainty of future terms require careful evaluation of the risks and rewards.

 

So, is it safe to do a SAFE? It depends. SAFEs offer benefits like speed and flexibility but come with risks such as dilution for founders and uncertainty for investors. Ensuring fair and protective terms for both parties is essential.

 

 

Written by: Richard Enoch (Associate)