Y-Combinator’s SAFE ("simple agreement for future equity") is becoming increasingly popular as an alternative to a convertible note.

A SAFE is a promise to provide an investor with future equity in a preferred round, in exchange for money today. It is akin to a convertible note, but without the loan terms.

SAFEs are far more entrepreneur friendly than traditional convertible notes. In contrast to a convertible note, the SAFE never really becomes due. One of the ways an investor can keep tabs on a startup is by knowing that at the end of the loan term, the loan will have to be paid back, extended, or converted at some predetermined valuation. This provides some measure of oversight, at least in theory.

The SAFE removes the loan terms, leaving at its core the promise to convert the investment into preferred shares, if and when the Series A (or other preferred financing) takes place. While this simplifies the seed and angel investment process, an investor loses leverage in keeping track of its startup investment.

On the other hand, startup investment is inherently risky, and a startup that looks promising but only has a month or two left in its note will likely be able to renegotiate an extension. A SAFE thus strips away the fiction that the investor is providing a loan, since most early stage investors are investing not to get the loan back with interest, but to see the startup go big. From that point of view, a SAFE can simplify the negotiation process if both the startup and the investor are aligned.

Before making a SAFE investment, an investor needs to make sure that the startup is aligned in its vision to eventually obtain a Series A or other preferred financing.

SAFEs are about as easy to get done as a convertible note round, and are unlikely to be used for large scale financing. The same securities compliance issues that apply to convertible notes will also apply to SAFEs.

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