Executive Summary
A Simple Agreement for Future Equity (SAFE) is a financing instrument for seed stage enterprises that allows investors to essentially buy future company shares. Similar to a convertible note, it acts as a short-term buffer, allowing the company to gain traction and grow before it carries out its next round of funding. Unlike a convertible note however, a SAFE is not a debt instrument but instead works as a warrant on future equity. It therefore isn’t tied to a maturity date or interest. This makes a SAFE a much easier and straight-forward financing tool. Depending on what has been agreed upon between both parties and in order to compensate investors for taking a high risk so early on, a SAFE can include discounts for purchasing future equity and a valuation cap.
When is a SAFE a good financing option?
Much like a convertible note, a SAFE is a more accessible and cheaper financing option than equity or bank loans, offering recipients a quick and straight-forward way to finance their activities and grow their business without having to immediately dilute company ownership and getting a company valuation (assessing a company’s worth). Unlike a convertible note however, a SAFE is not a form of debt, but rather an agreement that grants the investor the right for future equity (typically when the next funding round takes place). Since investors are essentially investing in your company’s future success, this tool should only be considered by companies that are expected to grow and gain significant customer traction.
The following (non-comprehensive) characteristics and implications provide you with an overview to analyse the pros and cons for this investment instruments:
| Enterprise Lifecycle | Seed |
| Amount | Depending on enterprise needs, but typically modest amounts |
| Pay-back period (Maturity) | No maturity date, since SAFE automatically turns into equity in the subsequent priced round |
| Use of funds | Mostly unrestricted |
Source: Based on (Roots of Impact, 2020)
The following table summarises some key characteristics of Convertible Notes and implications you should consider:
| Characteristics | What does this mean for your enterprise |
| Because of its relative simplicity, a SAFE has fewer legal and administrative costs in comparison to other financing tools | A SAFE is one of the cheapest financing options for you as an early-stage company. Since it doesn’t function as debt, there is no accrued interest, making it an attractive alternative if you are not ready for selling shares and do not qualify for traditional debt. |
| A SAFE typically has no maturity and no fixed deadline for conversion. It also doesn’t have an interest rate since it is not debt. | This enables your company to be much more flexible than if you used a convertible note, for example. However, bear in mind that with a SAFE, the investor accepts a higher risk and is not as protected against default. This means that you might need to include better perks, such as a higher discount rate on future equity, to attract investor interest. |
| Compared to priced rounds or other financing instruments, with a SAFE, there is minimal negotiation. | Given the simplicity of SAFE, you will only have to agree on key aspects like the amount to be invested, the valuation cap, and the potential discount on future equity. Nevertheless, in the terms and conditions you should also make sure to cover vital terms that protect both you and the investor. Think of scenarios for company dissolution or company acquisition, when there is an equity round, etc. If these terms haven’t been laid out properly or fully understood by both parties, there could be a misalignment of interests which could lead to unexpected negative outcomes for either of the parties. |
| Pro-rata rights or participation: Although a SAFE is neither debt nor equity, and only becomes equity when triggered, investors can receive pro-rata rights. | When issuing such rights, make sure you consider whether future investors are going to be put off by the number of pro-rata rights issued. Understanding how these rights will affect your future investment portfolio will help you make more informed decisions when issuing SAFEs. |
| Investors are not remunerated for the early-stage risk they are taking. In fact, they get paid only when the company raises additional funding (Roots of Impact, 2020). | This allows your company to have more flexibility and not be tied down by strict repayment schedules and interest rates. |
| Convertible instruments like SAFE postpone equity dilution | Think ahead: Founders living too much in the here and now, risk forgetting about future promises including any responsibilities or consequences associated to equity dilution. Make sure not to lose track of how much of your future company ownership (equity) you have already sold and what that means for the future of the company. |
Key features
Y Combinator has put together a series of templates of what different Post-Money SAFEs could look like. See the web-reference at the end of this factsheet. |
Tips to build your investment case as an early-stage water-related enterprise
Basic requirements
An early SAFE investor is accepting a higher risk than future investors who will get a clear idea of your company trajectory. Due to the simplicity inherent to a SAFE, investors also receive less protection in the eventuality of bankruptcy or if a company does not perform as expected, since they have no legal right to claim repayment from the company. SAFE investors are therefore putting all their trust in the founders and truly believe that the company will do well and that one day they will get their fair share of the cake. Where does this leave you, then?
As the founder, you will need to be fully aware of how a SAFE operates and decide whether your company will be able to afford doing a future priced round. If you are not confident, then this financing tool is probably not the right one for you. If, however, you are very confident that your company will grow, your customer traction will increase and within the next few years you will be able to raise financing through a priced round, then a SAFE could be a good financing option and a good alternative to a convertible note.
SAFE as a financing instrument for water, sanitation, hygiene and waste management early-stage enterprises
Bear in mind that many enterprises working in the water, sanitation, hygiene and waste management sectors in developing contexts sometimes struggle to be financially viable. If this applies to your business, you may be able to leverage on the socio-environmental impact of their work to receive financing. This often resonates with government institutions, philanthropic organisations or Development Financing Institutions (DFIs), but probably lack a strong argument for commercial investors that expect financial returns on investment.
There are, however, many water-related enterprises that meet SAFE requirements. As SAFE investors tend to be more familiar with other sectors such as the tech industry, you might still need to work hard to make a strong case for yourself. An entry point, for example, would be if your company works in any innovation- or tech-related area (for example smart water metering or farm sensing software) where some parallels can be drawn with tech companies that SAFE investors will likely have engaged with already. In this case you might find yourself in a better position to gain investor trust by providing relevant reference cases. Putting yourself into the investors shoes and carefully considering how you pitch your company is crucial to get your foot in the door.
Build a case for the potential of water-related markets
Since SAFEs are essentially a percentage of future company equity, an investor needs to be fully confident that your business will gain traction fast and will have increased in value by the time the SAFE is redeemable. The potential of the market you target can be a good entry point to build an investment case for yourself and convince the potential investor.
In the best case, your business model has already proven successful in other contexts or offers an innovative solution to an established and profitable market. While we are not big fans of plastic bottles, the global bottled water market provides a good example that everybody can easily relate to. This industry is well established and expects an annual growth rate of %6.1 for the period between 2020-2025, predominantly driven by a fear of drinking contaminated water (Mordor Intelligence, 2020). In markets for specific technologies, like smart water meters, growth rates are projected to be even higher, with more than 10% growth per year (XXXX 20XX).
If your water or sanitation businesses is targeting a market where references for successful investment cases are still lacking, you can try to draw parallels to adjacent markets with similar characteristics like renewable energy or waste industries. These markets have started and continue to undergone drastic shift that have been triggered by pressure on resources, population growth and the effects of the climate crisis. These same issues that led to the reinvention of the energy market, where demand for renewable energy is predicted to continue growing, are mounting pressure on water-related service systems. Increasing social pressure is mounting throughout the world to stop plastic pollution, and pollution of water resources through agricultural and industrial activity is also receiving more attention that will likely increase demand for more sustainable solutions in the future.
Leveraging your impact profile
If you find a SAFE investor with an impact agenda, you can leverage on your company’s potential to extend or improve basic services or adapt inclusive business approaches to lure investors in and agree on terms that link financial rewards to the achievement of impact. For instance, this could take shape by negotiating reduced discount rates or an increased valuation cap in relation to the achievement of impact targets (Roots of Impact, 2020).
If, on the other hand, you are not able to use impact to your advantage when approaching an investor (for example, in the event that the investor has no impact-driven agenda), it would be a good idea to carefully choose the language used in your pitch. Investors that have pre-conceptions about work falling under the “development” umbrella or that lack an understanding of the WASH/waste management sector could be put off by certain language used by founders that has typically been associated with philanthropic work.
Interesting options and variants you should know about to establish a suitable SAFE deal
You have brought an investor on board that is willing to explore SAFE investment into your company?! Great, here are a few of the concepts you should know about, when starting to negotiate a deal:
- Most favoured nation provision (MFN): This allows early SAFE investors not to set a valuation cap and instead, wait until they can see what the terms and valuation cap of future investors is. Early investors will be able to decide at a later point whether they want to amend their original terms or leave the terms as they are and simply add the valuation cap. For instance, if a valuation cap or discount is introduced in the new round of SAFE, the previous holders are entitled to amend their SAFE and receive the same terms (Roots of Impact, 2020).
- Discounts on future equity: A SAFE can include a discount (typically ranging between 10% and 25%) on the future equity. Depending on the perks in your SAFE and how much you need to convince your investor, this could prove to be a very useful negotiation tool.
- Pro-rata rights: These are additional perks for the investor that can help you make your investment case more attractive. They give the investor rights to invest funds in subsequent rounds in order to preserve company ownership percentage and avoid further dilution (Roots of Impact, 2020).
