Venture Financing Tips: Convertible Securities
Hear from Jesse Jones, Fourscore Business Law Founder, about Convertible Securities. In this video, Jesse focuses on just one concept: SAFEs. SAFE is the Simple Agreement for Future Equity. Stay tuned for the next video in our Venture Financing Tips series and subscribe to our monthly newsletter full of resources here.
For entrepreneurs, the prospect of raising funds to propel business growth should come with a mix of excitement and fear. While taking angel and venture capital isn’t right for every startup, it may be the ideal financial structure to help you scale.
Download our whitepaper here, including a directory of funding sources in North Carolina and the Southeast.
Venture capital gives you the opportunity to raise significant amounts of funding by essentially selling a part of your company as you build it. For that reason, entrepreneurs should understand that angel and venture capital is typically expensive money, so the smartest entrepreneurs will make sure to seek outside capital from those that can provide value in terms other than simply dollars.
If you are planning to meet with a potential investor, understanding what to expect when it comes to structuring venture deals will help ensure you get started on the right foot.
Venture Financing Tips: Convertible Securities
In this video, we're going to cover one common type of convertible security used in startup financing, the SAFE. SAFE stands for Simple Agreement for Future Equity.
You can think of a SAFE as something similar to a convertible note, but with one important difference. It's not dead. At least most CPAs agree that it's not dead. You might find some that still say this.
That means that there's no interest and no obligation for the company to repay the investment money. Instead, an investor puts money into the company today, and everyone agrees that the investment will convert into equity later. SAFEs are popular because they make early-stage fundraising faster and simpler.
Rather than negotiating the company's valuation right away, that conversation gets pushed to the next major financing round. When that major financing happens, the SAFE converts into equity, usually the same type of preferred stock that's sold to new investors. Most SAFEs include either a discount or a valuation cap.
In the past, there used to be some versions of SAFEs that had both, but you don't see that so much anymore. A discount means that the SAFE investor gets to buy shares at a price lower than the new investors. For example, if the next round investors pay $1 per share and the SAFE has a 20% discount, then the SAFE investor would convert their investment at $0.80 per share.
A valuation cap sets a maximum company valuation that will be used when calculating the conversion price. This gives early investors some protection if the company grows quickly before the next financing. Sometimes, SAFEs convert into the same exact shares that the new investors purchase.
Other times, they convert into what's called a shadow series, which is almost identical stock, but with a liquidation preference based on the SAFE investor's actual conversion price. This structure helps keep things fair while still rewarding those early investors who took the first risk. That's a quick overview of SAFEs.
For more venture financing tips and resources, visit fourscorelaw.com and check out our YouTube channel.
Common Questions About Venture Financing Tips: Convertible Securities
-
A: A SAFE (Simple Agreement for Future Equity) is a contract where an investor puts money into a startup today, and that investment converts into equity later during a future financing round. Unlike a loan, it has no interest and no repayment obligation.
-
A: A SAFE is not debt, meaning the company owes no interest and doesn't have to repay the money. A convertible note is a loan that must be repaid, while a SAFE simply converts into equity when the next major funding round happens.
-
A: A discount lets SAFE investors buy shares at a lower price than new investors — for example, $0.80 per share instead of $1.00 with a 20% discount. A valuation cap sets a maximum company valuation used to calculate the conversion price, protecting early investors if the company grows quickly.
-
A: A SAFE converts into equity when the company completes its next major financing round. It typically converts into the same preferred stock sold to new investors, or into a "shadow series" — nearly identical stock with a liquidation preference tied to the SAFE investor's actual conversion price.