The Simple Agreement for Future Equity (SAFE) is a nifty little template developed by the creative brains behind Y-Combinator. This peculiar form of agreement has taken the startup community by storm, offering itself as a tool for making fundraising processes easier and friendlier to the startup founder.
Since its release, the SAFE promised to be founder friendly which is well and good, but how secure is it in practice and do any legal risks lurk in the simply laid out legal jargon, especially when being used across jurisdictions?
We have to remember this document was birthed in another country with an entirely different legislative system to any country in the GCC. Yet, many founders found comfort in using it in its nascent form, without really understanding the legal jargon or the extent to which the legal jargon may require review.
In this article, we have undertaken an examination of SAFE documents, and put together an analysis of how a GCC founder can better adjust this popular instrument to meet investment needs.
1. No protective provisions
A “down round” occurs when your startup raises money at a lower valuation than before. In this situation, the original SAFE doesn’t offer much protection for founders because it lacks what are known as “protective provisions”. These are special clauses that could help safeguard a founder’s ownership stake in the startup, even if a down round occurs.
An example of a protective provision is “anti-dilution rights”. These rights help ensure your ownership percentage doesn’t get too diluted if your startup issues new shares at a lower price. However, the original SAFE does not include anti-dilution rights, leaving founders vulnerable.
2. No liquidity options
Liquidity refers to being able to turn your stake in a startup into cash, which is important for founders who want financial stability or to fund other projects. But in the world of startups, traditional exits like IPOs and acquisitions can take years or even never happen. So, what do you do when you need money, immediately?
Well, you could try negotiating with your SAFE agreement to include secondary transaction rights. That way, even if your startup isn’t sold or goes public, you could still sell some of your shares to investors, giving you some liquidity. Another option is to explore alternative liquidity mechanisms, like employee stock option plans (ESOPs) or revenue-based financing.
The lack of founder liquidity options can be particularly challenging in the GCC region, where traditional exit events may be less common or take longer to occur compared to other markets, such as the US. It is not a perfect solution but it can help you get by, until your big break comes along.
3. No clear process for major triggers
One of the key issues with the original SAFE form is that it does not set out clear processes for handling major triggers, such as equity financing or liquidity events. This lack of clarity can lead to confusion and potential disputes between founders and investors.
If we are to consider the example of equity financing, the SAFE form includes a provision that allows the SAFE to convert into equity at a discount or valuation cap when the startup raises a priced round of financing. However, the SAFE does not specify the precise mechanism for how such conversion will occur.
This can be problematic if there are disagreements between founder and investor about the terms of the conversion. For example, what happens if the investor decides they do not want to convert their SAFE into equity during the priced round? Or what if the investor wants to convert their SAFE into equity but in the name of another entity, such as a family office or trust?
Without clear processes in place for handling these situations, founders may find themselves in a difficult position. They may be forced to negotiate with investors individually, which can be expensive and time consuming. In some cases, lack of clear processes could even lead to legal disputes that can drain the startup’s resources and distract from the core business.
4. No restrictions on investor rights
The original SAFE does not prevent or limit the investor’s ability to transfer their rights to a third party. This means your investor could potentially sell their stake in your startup to a third party and at the time of equity financing, instruct you to transfer the shares to such third party. In cases of inexperienced and unsophisticated angel investors particularly, this is a looming risk. Adding in specific investor restrictions are quite important—especially from a founder’s perspective—because this brings clarity to the agreement that you have with the investor.
To mitigate this risk, founders should consider negotiating for the inclusion of clear transfer restrictions in their SAFE agreements. This lends clarity to the status of the investor’s interest until a trigger event.
As discussed, it is clear from a GCC legal perspective that SAFEs are fallible and have disadvantages if you are using them without careful review and an understanding of the terms. The popular saying goes, “no risk, no reward” but know-how (from experience), consistency in purpose, and small abandon can help you come out victorious in the field of startup finance.
By Bianca Gracias, managing partner at Crimson Legal, a boutique legal consultancy based in the UAE.
