Convertible instruments, particularly Simple Agreements for Future Equity (SAFEs), have become popular tools in early-stage financing. These instruments offer flexibility to both investors and founders, bridging the gap between early-stage funding needs and traditional equity financing.

How Do SAFEs Work?

A SAFE is an instrument under which investors inject capital into a company in exchange for shares at a future point in time. Generally, SAFEs do not have features commonly found in debt instruments, such as interest rates, making them a more company-friendly alternative to debt.

Typically, SAFEs convert into equity upon the occurrence of a ‘trigger’ event. The market-standard trigger events are:

• A qualifying equity financing round – This occurs when the company raises funds through the issuance of shares, known as a ‘Qualifying Financing’ round. Sometimes, the Qualifying Financing is tied to a minimum funding threshold, allowing the company to undertake a smaller, bridging finance round before a major capital raise without causing the SAFE to convert into equity.
• The sale of all or substantially all the company’s shares, assets, or an IPO – This is known as an ‘Exit Event.’

Why Would an Investor Invest in a SAFE?

Investors agree to invest money in exchange for future shares for several reasons:

• Discount or Valuation Cap – Investors generally receive an incentive in the form of a discount or valuation cap, allowing them to receive shares at a lower price upon conversion.
• Avoiding Debt Burdens – Investors who believe in a startups long-term potential may prefer SAFEs over debt-like instruments, such as convertible notes, as they do not add liabilities to the company’s balance sheet or impose financial burdens like interest payments.
• Early Positioning – SAFEs allow investors to secure an early position in a startup before a formal valuation, potentially leading to higher returns upon conversion, and eventual exit.
• Lower Negotiation and Transaction Costs – SAFE funding rounds typically require less negotiation and are quicker and less costly than debt or traditional equity financing rounds.

Emerging Trends

Through advising companies and investors in SAFE investment transactions over several years, our team has observed the following trends:

• SAFEs are the dominant fundraising instrument for pre-seed and pre-revenue companies in Australia
  SAFEs have become the preferred funding instrument for early-stage companies due to their simplicity. Unlike priced equity rounds, SAFE rounds allow startups to defer setting a formal valuation, which can be useful when financial traction is minimal.

• Bespoke SAFEs are becoming more common

  Originally designed as a ‘one-size-fits-all’ financing tool, SAFEs are now being tailored to meet the unique needs of companies and investors. For example, many SAFEs now include a ‘maturity date’ or ‘long-stop date,’ upon which the SAFE automatically converts into equity if an earlier trigger event has not occurred. Maturity dates are typically 12-36 months from the SAFE’s issuance date. While SAFEs do not accrue interest or provide investor rights (such as voting rights), the investor’s realised value may increase if the company experiences growth before conversion. Therefore, the SAFE’s maximum term must be carefully considered.

• SAFE ‘stacking’ is on the rise

  Many startups are ‘staking SAFEs’. This refers to the practice of issuing multiple SAFEs over time rather than raising a single, consolidated SAFE round. While this provides continuous access to capital, it comes with risks:

• • Cap Table Complexity – Multiple SAFEs with different terms can make share price calculations in later fundraising rounds more complicated.
  • Dilution Risk – Accumulating too many SAFEs before a trigger event can lead to unexpected dilution for founders and existing shareholders, particularly since SAFEs already include incentives to maximise investor holdings upon conversion.
  • Most-Favored Nation (MFN) Clause Complications – Many SAFE investors often request ‘most-favoured nation’ (MFN) rights. This means that if the company issues a SAFE on more favourable terms than those offered to an earlier SAFE investor (before the earlier SAFE converts), the earlier SAFE investor has the right to ‘upgrade’ its terms to reflect those better terms. Founders often overlook MFN rights, leading to unintended contractual breaches. Additionally, MFN clauses can require companies to amend the terms of numerous SAFEs, creating costly and time-consuming administrative burdens. While MFN rights are critical for investors, companies should carefully consider their implications.

• Increased Use of Side Letters

  Sophisticated and professional investors frequently negotiate additional rights in connection with SAFE investments via separate Side Letter agreements. Common provisions include:

• • Pre-emptive Rights – The right to participate in the company’s Qualifying Financing round.
  • Information Rights – The right to receive financial and other company reports, often crucial for investor compliance and reporting.
  • Governance Provisions – Requirements that certain rights be incorporated into the company’s governance documents when the SAFE converts, such as the right to freely transfer shares to affiliates, pre-emptive rights on share issuances and disposals, and protections in exit events. Companies should carefully assess these requests to avoid committing to rights that may not align with future investor expectations.

• Fixing the Class of Shares Receivable on Conversion

  When a SAFE converts as part of a Qualifying Financing, the investor typically receives the highest class of shares issued in the funding round. Since the rights attached to those shares are unknown at the time the SAFE is signed, some investors attempt to lock in specific preference share rights at the time the SAFE is negotiated. However, this approach should generally be avoided, as it may restrict the company’s ability to freely negotiate terms in its Qualifying Financing round.

Contact Us

Convertible instruments, particularly SAFEs, remain integral to early-stage financing. While SAFEs continue to gain traction due to their simplicity and company-friendly nature, market standards are constantly evolving. Companies and investors should carefully evaluate SAFE terms before entering into these agreements.

For expert guidance on SAFEs and capital raising strategy, contact our experienced corporate transactional lawyers at 03 9481 2000 or info@tauruslawyers.com.au.