Congratulations! You are a new startup. You have the idea, the business plan and now you need the initial financing. If you have an angel – great! If your sister-in-law is a venture capitalist or your family owns a bank – great! If not, you might need to go outside the realm of traditional financing options (banks) or even less traditional financing options (convertible debt or preferred stock). Welcome to the world of SAFEs and KISSes.
The SAFE (Simple Agreement for Future Equity) is a short document that contains the basic terms of an investment in an early stage company. The SAFE was first proposed as an instrument in December 2013, but it is just now beginning to be used outside of Silicon Valley. The SAFE is the creation of the American seed accelerator, Y Combinator. The SAFE creates standard, pre-agreed terms and conditions that govern the investment.
The basic concept is that the investor provides funding to the company in exchange for the right to receive equity upon some future event. The standard SAFE contains no term or repayment date, and no interest accrues. The investor gets the right to receive the company’s equity when a future event occurs (normally a future equity financing). There is no reason to negotiate the company’s value, terms of conversion to equity or any similar items. This will all be done in the future. The investor will receive shares in the subsequent offering, often at a discount to the price that other investors pay in that offering. The parties can also negotiate a cap on the valuation used in connection with the SAFE, and this may provide additional protection to the investor. The draw of the SAFE is that the initial financing proceeds quicker since there is a deferral of the major terms of the investment and effectively puts it off until a future transaction – conceivably the future financing round. The SAFE investor is relying on the terms of the subsequent financing round to protect its position. This type of investor must be agreeable to uncertainty.
500 Startups is largely credited with the creation of the KISS, or “Keep it Simple Security.” Again, KISSes like SAFEs could lack interest payments or a maturity date or the second type does include maturity dates and interest rates.
These alternative forms of financing and investment structures do get rid of costly negotiations on the major terms of the financial transaction – at least until the next round.
Michael C. Carroll, Esq., Managing Partner, CorpGen Counsel brings a wealth of securities, governance, M&A, private equity, real estate, transactional, and general corporate law experience to public companies, privately-held companies, private equity firms, and individual clients. Mr. Carroll was previously Senior Vice President, Chief Compliance Officer, and General Counsel of Medallion Financial Corp., a NASDAQ-traded commercial lender and FDIC-insured bank, and was Senior Counsel of Aames Investment Corporation, a NYSE-traded real estate investment trust. Prior to his in-house positions, he practiced in the corporate law department of the international Am Law 50 law firm of Willkie Farr Gallagher, LLP in New York.