Raising capital is one of the biggest challenges for startups and small businesses in Saudi Arabia. While traditional equity financing can lead to early dilution and complex negotiations, Simple Agreements for Future Equity (SAFEs) offer a more flexible and founder-friendly alternative. Designed to simplify fundraising, SAFEs allow startups to secure investments now while deferring valuation decisions until a future priced round.
In this blog, we’ll explore how SAFEs can optimize fundraising, protect founder equity, and support sustainable business growth.
What Is a SAFE?
A Simple Agreement for Future Equity (SAFE) is a financial instrument where an investor provides capital upfront in exchange for the right to receive equity at a later stage—typically when the startup raises funds through a priced round. Unlike traditional equity investments, SAFEs streamline the funding process by eliminating immediate valuation concerns, making them an attractive option for early-stage companies.
Benefits of SAFEs for Startups and Investors
SAFEs offer multiple advantages for both startups and investors, with simplicity being the most significant benefit. By streamlining the fundraising process, SAFEs reduce complexity and accelerate investment decisions. But how exactly do they benefit both parties? Read on to explore the key advantages of using SAFEs.
How SAFE Negotiations Work
One of the key benefits of SAFEs is their simplicity. Unlike priced rounds that require extensive negotiations, SAFEs typically involve only two key terms:
- Investment Amount – How much the investor is putting into the company.
- Valuation Cap – The maximum valuation at which the SAFE converts into equity.
This limited scope of negotiation makes SAFEs faster and easier to execute compared to traditional financing options.
What Happens in the Next Priced Round?
Many startups begin fundraising with SAFEs and later transition to a priced round when a lead investor sets the valuation. At this stage, SAFEs convert into shares based on the agreed terms, aligning with the negotiated conditions of the priced round. This ensures a seamless transition from early-stage funding to more structured equity financing. and provides a clear path to structured equity financing.
Types of SAFEs
Startups can structure Simple Agreements for Future Equity (SAFEs) in different ways based on their fundraising needs. While all SAFEs serve the same purpose—securing investment without immediate valuation—there are key variations. Below are the main types of SAFEs and what they mean for startups and investors.
1. Discount with No Valuation Cap
This SAFE offers the investor a discount (20%) on the future priced round without setting a valuation cap. This means investors pay less per share than new investors in the priced round. However, since early investors typically seek additional incentives, this structure is uncommon.
2. Valuation Cap with No Discount
A valuation cap sets a maximum price at which the SAFE converts into equity, protecting early investors if the startup’s valuation rises. In this case, there’s no additional discount on the priced round, making it straightforward for both parties.
3. Valuation Cap with Discount
This is one of the most common SAFE structures. Investors receive both a valuation cap and a discount, giving them better terms than later-stage investors. This approach balances investor incentives while keeping fundraising simple.
4. No Valuation Cap, No Discount
In this structure, investors receive equity at the same price as new priced-round investors, with no cap or discount. Since it offers no financial advantage for early investors, it is rarely used.
5. No Valuation Cap with Most Favored Nation (MFN) Clause
This SAFE doesn’t set a valuation cap but includes an MFN clause, meaning if the startup later offers better terms to another investor, the original investor gets the same terms. This can be useful when founders need funding early but are unsure of a fair valuation. However, it adds administrative complexity.
Standard Structure of a SAFE
The structure of a Simple Agreement for Future Equity (SAFE) is straightforward and typically spans just five pages. Here’s a breakdown of the key sections and what they mean:
1. Section 1: Key Terms and Events
This section outlines the valuation cap and the payment terms from investors. The main negotiating points are typically the valuation cap, and the amount of money invested.
It also covers important events like equity financing, liquidity events, and dissolution scenarios. It explains what happens if the company is sold or shuts down before the SAFE converts into equity. The section also clarifies liquidation priority, ensuring investors know the order of repayment in these events.
2. Section 2: Definitions
This section defines key terms used throughout the SAFE. For example, it will explain what “company capitalization” means, helping both parties understand the terms.
3. Section 3: Representations from the Company
Here, the startup affirms its legal standing, such as being properly incorporated and compliant with relevant laws. This gives investors assurance about the company’s legitimacy.
4. Section 4: Representations from the Investor
This section confirms the investor’s status, such as ensuring they are accredited, complying with relevant regulations.
5. Section 5: Legal Boilerplate
Finally, this section includes the legal formalities required for the agreement to be valid, ensuring that both parties are protected in case of disputes.
SAFE vs. Convertible Notes: Key Differences
A common misconception is that SAFEs function like convertible debt instruments. However, there are key distinctions:
- SAFEs are not debt. Unlike convertible notes, they do not carry an interest rate or a maturity date requiring repayment.
- Both instruments convert into equity, but SAFEs offer a simpler, more startup-friendly structure.
So, understanding these differences is crucial when selecting the right financing option for your business.
Startup Company’s Dilution Cycle
Understanding dilution and how it impacts your cap table is crucial for founders. Here’s a simplified breakdown of the dilution process:
- Company Incorporation: The company is established, and initial shares are issued to the founders.
- Raising Money with Post-Money SAFEs: When founders raise capital through post-money SAFEs, the dilution process begins.
- Issuing Equity to Employees: As the company grows, equity is also issued to key employees.
- Priced Round: The company will eventually conduct a priced round, which finalizes the valuation and equity distribution.
- Cap Table Impact: This results in changes to the cap table, reflecting the ownership percentages of the founders, investors, and employees.
Case Study: Dilution Example
In a simple startup with two founders, each founder starts with 4.625 million shares (50% ownership). The company issues a total of 9.25 million shares.
Investor A invests $200,000 at a $4 million post-money valuation cap. This results in 5% ownership for Investor A.
Investor B invests $800,000 at an $8 million post-money valuation cap, resulting in 10% ownership for Investor B.
At this point, the founders have sold 15% of the company, meaning they now own 85% of the company, even though these are just SAFE agreements (no actual shares issued yet). The dilution has already taken place, though the cap table won’t reflect this until the SAFEs convert into shares during a future financing round.
Common Questions from the Case Study
1. Who gets diluted at the second post-money SAFE note of Investor B?
Only the founders will be diluted on Investor B’s SAFE investment because that’s the construct of the post-money SAFEs. The latest SAFE investors don’t dilute the earlier SAFE investors; they dilute the existing shareholders. And at this stage, it’s just the founders who are the existing shareholders.
2. Is it necessary to have authorized but unissued shares for SAFE Notes?
No, the company will create new shares that the founders will issue to these SAFE holders when they convert. So, at the SAFE stage, it’s OK just to have the shares that the founders have.
3. Why do Investors A and B have a different post-money valuation cap?
They have different post-money valuation caps because they invested at different times. Investment A occurred a month after incorporation, while Investment B happened six months after. As more time passed, the company de-risked, and its valuation increased, allowing Investor B to negotiate a different cap.
4. What happens when founders hire and issue equity to employees?
The company creates an option pool (or ESOP) to allocate equity to employees. This option pool dilutes the founders, and it affects the cap table by increasing the number of shares issued. In the example provided, the company issued 650,000 shares from a pool of 750,000 shares, changing the ownership percentages.
5. What is a fully diluted Capitalization Table?
A fully diluted capitalization table includes both the issued shares and any unissued shares reserved in the option pool. For example, after issuing 650,000 shares to employees from the option pool, the company has a total of 10 million shares, including both the shares issued and those reserved for future employees.
6. What happens at the next priced round?
The company raises a new round at a higher pre-money valuation (e.g., $15 million) and a post-money valuation (e.g., $20 million). Part of this new investment involves increasing the option pool for future hires, typically to around 10% of the post-money shares.
7. Is the 10% for the ESOP coming from the founders or collectively?
Answer: The 10% for the employee option pool will dilute the existing shareholders and SAFE holders, but it will not dilute the new investors (i.e., the Series A investors).
8. How is the option pool represented on the cap table?
The option pool is shown separately for issued options (which are considered outstanding shares) and unissued options (which are not outstanding). The fully diluted cap table includes both issued and unissued options as part of the total share count.
9. How does the cap table work after post-money SAFEs?
In the subsequent priced round, the SAFEs convert into shares, and the newly created shares from the option pool are included in the pre-money calculations. Although SAFEs are called “post-money” SAFEs, this term refers to how the SAFEs convert into shares and not the price per share calculation in the next priced round.
10. How do you calculate SAFE-converted preferred shares?
After the SAFEs convert into shares, the percentage of the company owned by SAFE investors is determined based on the post-money valuation cap. For example, if SAFE A converts to 5% of the company, and SAFE B converts to 10%, the cap table reflects these conversions, along with the founders’ dilution.
11. Does the 5% and 10% have anything to do with the subsequent price round?
Yes. The 5% and 10% represent the percentage of the company owned by SAFE investors based on their post-money valuation cap. If the priced round valuation is higher than the valuation cap, the SAFE investors will receive a better deal, but if the priced round valuation is lower, their percentage will increase.
12. Is a higher post-money valuation beneficial for founders?
No, founders should be cautious about agreeing to too high of a post-money valuation cap for SAFEs. A high valuation cap may result in giving up more equity than expected during a price round, as it could lock in the SAFE investors’ equity percentage.
13. Where is convertible debt shown on the cap table?
Convertible debt would appear on the cap table in the same way as SAFEs, as the debt converts into equity during the priced round. It’s slightly more complex due to interest accrual and maturity dates, but it follows similar principles to SAFEs.
14. How does the cap table work for the priced rounds?
If the priced round is higher than the SAFE cap, the SAFE investors get more shares for their money. If the priced round is lower than the SAFE cap, the SAFE investors get a better deal because their conversion price is based on the lower priced round valuation.
15. What happens when you raise money with both convertible notes and SAFEs?
It’s not ideal to raise money using both SAFEs and convertible notes simultaneously, as it complicates the calculations for conversion. It’s better to stick with one method for simplicity, with SAFEs being the more straightforward option.
16. Is it possible to issue pre-money and post-money SAFEs for the same company?
While it is possible, it is generally recommended to use post-money SAFEs for simplicity. Using both pre-money and post-money SAFEs can lead to confusion and make calculations more complicated.
SAFE Notes in the Gaming Sector
In the gaming industry, SAFE Notes play a critical role in enabling startups to secure early-stage funding without overvaluing their business prematurely. This flexibility is especially valuable for gaming studios, which often face high upfront development costs, fluctuating revenue streams, and long production cycles. By using SAFEs, gaming founders can focus on creating innovative titles, expanding into esports, and developing platforms, while maintaining control over equity and long-term growth strategy. This makes SAFEs an ideal tool for supporting sustainable growth in the rapidly evolving Saudi gaming ecosystem.
Conclusion
In conclusion, this guide, prepared by the J&G Professional Services experts, has highlighted the flexibility and efficiency that SAFEs offer startups in Saudi Arabia.
By streamlining the fundraising process, SAFEs provide a founder-friendly alternative to traditional equity financing, allowing startups to secure capital without the immediate need to set a valuation.
Through various SAFE structures, both founders and investors can align their interests, while also minimizing dilution during early-stage financing.
