By Fernando Berrocal

As a new founder, you were inspired to help serve a sector and want to grow your startup with as few hiccups as possible. The rise and fall of a startup can be swift, so knowing the funding techniques that are best suited to your startup is critical. 

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To help new founders understand more clearly the funding options available to them, we are going to explore SAFE notes through the following topics:

• What is a SAFE note and how does it work?
• How do you Implement a Rolling Raise Strategy?
• The definition of a Valuation Cap.

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What is a SAFE note? The second most common method of funding employed by early-stage startups to gain early Venture Capital is a SAFE (Simple Agreement for Future Equity). A SAFE allows entrepreneurs to receive money in return for equity, it converts to shares later. They nearly always mature at the following round of financing because they were created primarily for startup investment (a Seed Round or Series A). Since convertible equities such as SAFEs don't expressly place a price on the organization's shares, the fundraising round they facilitate is known as an unpriced round.

SAFEs are a newer type of fundraising mechanism that works similarly to warrants, allowing investors to acquire a certain number of shares in the following round. YCombinator established SAFEs to replace convertible notes in unpriced rounds. However, both instruments are being utilized concurrently because certain investors prefer one financial instrument over the other.

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How a SAFE Works: SAFE notes introduced by YCombinator in 2013 as an alternative to “Convertible Notes”, are currently in their second generation and remain slightly less complex than convertible notes in their most recent iteration. SAFEs were designed to be used directly for unpriced investment rounds at businesses. They also have a valuation cap and discount rate that apply when they convert during the next equity round. They don't, however, have a maturity date or pay interest, features that benefit founders but are not usually desirable to investors.

SAFEs have the option of converting at either a pre- or post-money valuation. When it comes to early-stage investing and angel deals, the majority of the benefits come from taking risky bets and receiving large returns on equity. Setting an artificial deadline for the next equity funding round isn't in the organization’s or investors' best interests, since they only earn their desired investment returns from your startup's exponential development and continuing success. An early-stage investor who is fixated on phrases like maturity date and interest rate might be a red flag. Most savvy investors you interact with are likely to be using SAFEs at this point.

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Implementing a Rolling Raise Strategy: SAFEs make it exceptionally easy to adopt a rolling raise strategy, in which you close multiple groups of new investors at varying prices (e.g. 10, 11, 12 million) throughout a single "round" due to the way they function. Businesses can use this method to take away price-setting authority from investors by imposing their valuation cap. By arbitrarily choosing closure dates at which the limit would climb, it also promotes “FOMO” in investors considering a deal.

The rolling raise and related tactics are sometimes referred to as "high-resolution finance," which essentially refers to the practice of establishing various valuation caps or values for different SAFE holders. SAFEs are a suitable choice for this approach since they are easy to implement, as they don't require any legal examination and their terms are standardized, save for the additional stipulations that may be inserted inside letters attached to the investment. Converting SAFEs to stock, on the other hand, might be a pain, especially if the business has SAFEs with Most Favored Nation (MFN) conditions.

SAFE + MFN (Most Favored Nation): If it is coupled by an MFN provision, a basic SAFE can be issued without a value cap or dilution restrictions. The MFN provision will allow an investor who completed a SAFE to obtain the same terms as the earlier investor if a subsequent investor executes a SAFE to invest in the business with terms more favorable than the earlier investor. This includes an MFN clause that might help alleviate early startup investors' concerns about later investors obtaining preferential rates.

A Few Words on the Valuation Cap: While the valuation cap isn't a "valuation" in the sense of a 409a valuation, it is one of your overall valuation methods, and it does set the tone for future financing—be careful when deciding on yours. Like convertible notes, SAFEs can cause future dilution if their valuation cap is low or if many SAFE investors are added without due consideration.

Disadvantages of SAFE Note: While SAFEs are essentially simpler than convertible notes in that they do not have a maturity date or pay interest, they do have their own set of drawbacks. Because SAFEs have no maturity date and convert at the next priced round of funding, it's feasible that they'll never convert if the business doesn't accept another priced round of financing. Though this is uncommon, it does happen.

Ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.

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