SAFE Notes: A Guide for Singapore SME Owners

A SAFE (Simple Agreement for Future Equity) note is an agreement between a company and an investor that provides the investor with the right to receive equity in the company at a future date, typically when the company raises a subsequent round of financing. SAFE notes do not have the complexities of convertible notes, such as interest payments, maturity dates, and the need for renegotiation if the note isn’t converted before the maturity date. SAFE notes are most commonly used by startups and early-stage companies because they offer a low-cost, flexible way to raise initial capital. Venture capitalists and angel investors may prefer SAFE notes because they allow them to invest in a company without having to set a valuation immediately.

Key Features of SAFE Notes:

• No Debt or Interest: SAFE notes are not loans, so they don’t accrue interest and don’t have to be repaid. They give investors future equity instead of a promise of repayment.
• Conversion to Equity: SAFE notes convert into equity (ownership shares) when the company raises a qualifying round of funding (e.g., Series A round). This typically happens at a discount or based on a valuation cap that benefits the early investor.
• No Fixed Valuation: SAFE notes are typically used in early-stage fundraising when the company’s valuation is uncertain or hard to determine. This flexibility allows companies to defer setting a valuation until a later round of financing.
• Simple to Use: SAFE notes are designed to be easier to negotiate and execute than other fundraising instruments like convertible notes or traditional equity rounds. They are usually much shorter and less complicated than other investment contracts.
• Investor Upside Protection: SAFE notes often include provisions such as valuation caps and discounts to protect investors and reward them for investing early. A valuation cap sets a maximum price at which the SAFE will convert into equity, ensuring early investors get a better deal if the company’s value skyrockets.

How SAFE Notes Work

Let’s imagine a startup needs to raise $1 million in capital and offers SAFE notes to early investors. The investors contribute capital today, but instead of receiving shares immediately, they receive a promise of future equity. The SAFE agreement might include:

• A valuation cap of $5 million, meaning the investor’s SAFE will convert at a maximum valuation of $5 million even if the company’s value grows higher than that in a future round of financing.
• A discount rate of 20%, meaning that when the company raises its next financing round, the investor will receive shares at a 20% discount to the new round’s share price.

When the startup later raises $10 million in a Series A round at a $10 million valuation, the SAFE note automatically converts into equity shares at the previously agreed valuation cap of $5 million or at a 20% discount from the Series A price, whichever benefits the investor more.

Benefits of SAFE Notes Compared to Other Fundraising Sources

• No Debt Obligation: SAFE notes aren’t loans, so businesses do not have to worry about repaying them or paying interest.
• Simplified Process: SAFE notes are quicker and simpler to execute compared to equity rounds or convertible notes.
• Investor Attraction: Investors are often more willing to invest through SAFE notes as they receive future equity without immediate risk.
• No Valuation Pressure: Unlike equity funding rounds, SAFE notes do not require setting a company valuation at the time of issuance, which is beneficial for early-stage startups that may not have a clear valuation.

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Procedure for Issuing SAFE Notes

Step 1. Preparing the Agreement 

• Work with legal counsel to draft a SAFE note agreement that includes the amount of the investment, any discount on future shares, and any valuation cap.

Step 2. Offering to Investors

• Present the SAFE note to potential investors, explaining that they will receive equity at a future funding round.

Step 3. Closing the Deal

• Once investors agree, both parties sign the agreement, and the funds are transferred to the company.

Step 4. Conversion to Equity

• At the time of the next qualifying funding round, the SAFE notes automatically convert into equity shares, typically at a discount to the new valuation.

Legal Obligations After Issuance of SAFE Notes

• Disclosure Requirements: The company must disclose the issuance of SAFE notes in its financial reports, typically as part of its capital structure.
• Investor Rights: Depending on the terms of the SAFE note, investors may have certain rights, such as the ability to receive future shares at a discount or a capped valuation.
• Compliance with Securities Law: The issuance of SAFE notes must comply with securities regulations in the company’s jurisdiction.

What Happens if the Company Incurs Losses and Can’t Repay SAFE Notes?

• No Repayment Obligation: SAFE notes do not need to be repaid like traditional loans, so if the company incurs losses, there is no debt to repay.
• Loss of Investment: If the company never raises another round of funding or goes bankrupt, the investors may not receive any equity, effectively losing their investment.
• Company Liquidation: In the event of liquidation, SAFE note holders are generally last in line to receive any residual funds after creditors and other obligations are paid.

Summary

SAFE notes offer a flexible, founder-friendly way to raise funds without the immediate burden of debt or equity dilution. However, the simplicity comes with risks, particularly for investors who could lose their money if the company doesn’t succeed. Understanding the pros and cons, as well as the legal and financial implications, is key for businesses considering SAFE notes as a fundraising option.

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