A new, unusual trend is emerging in the world of small startup fundraising. Many entrepreneurs are beginning to steer away from the typical tactics such as selling equity and issuing convertible notes for a new technique known as a Simple Agreement for Future Equity (SAFE). Investors who enter into these agreements with startups receive no equity shares, but rather get a warrant permitting them to a stake of the company in its next round of financing, acquisition, or IPO. The investor receives nothing if the business fails.
Vinayak Ranade funded his startup, Boston-based Drafted Inc., through the use of SAFEs. This technique allowed Ranade to acquire funding without having to set a valuation for his company in its very early stages. SAFEs are also less complicated and more borrower friendly than convertible notes.
These agreements are getting mixed reviews from an investor’s standpoint. Katherine O’Neill, director of the Jumpstart New Jersey Angel Network, said “We don’t like [SAFEs] because they don’t reward the early-stage investor for the large startup risk.” She has seen, and turned down, three of these deals in the past year. On the other hand, some investors see these SAFEs as an intriguing investment in a frothy startup market. Unlike convertible notes, SAFEs do not have a maturity or interest rate. Investors can wait forever for a “liquidity event” to claim their equity in a company.
Carolynn Levy, an attorney at Y Combinator, drafted the five-page Simple Agreement for Future Equity document. Y Combinator is a Silicon Valley accelerator that has helped startups such as Dropbox Inc. and Airbnb Inc. She believes that the relationship between a startup and investor should be more than just capital based. “I don’t think angels should be lenders,” she said. “They should be investors.”
As more and more investors begin to enter the startup scene hoping to find the next “big thing”, look for SAFEs to become more popular. Startups are gaining leverage in this frothy market, and that plays well for SAFE fundraising.