SAFE Deal Structure Gains Momentum

canstockphoto8468439Back in the days of the internet boom, it was straight up equity, then it became convertible notes.

Now, the SAFE deal structure is gaining momentum as the structure of choice for certain investments in fintech startups. This after Y-Combinator, the incubator, posted details on its SAFE agreements last February.

SAFE, which Y-Combinator first started using in 2014, stands for simple agreement for future equity. A SAFE is often used in the start-up context and accomplishes the same general goal as a convertible note without the obligation for repayment, since convertible notes generally morph into debt.

To offer a scenario, let’s say an accelerator wants to gain equity in one of its startups. It is in both the accelerator’s and the startup’s best interests that the equity should be distributed only if the startup rocks up to a much greater valuation then when the startup joins the accelerator. The SAFE would have the equity distributed upon a valuation over a certain level, say, $20 million. But if the startup does not achieve that valuation, there is no equity distribution and there is no debt created, as in a convertible note.

Here’s the No. 1 reason why Y-Combinator has moved to SAFEs:

Unlike a convertible note, a SAFE is not a debt instrument. Debt instruments have maturity dates, are typically subject to certain regulations, create the threat of insolvency, and can include security interests and sometimes subordination agreements, all of which can have unintended negative consequences for startups.

It should be noted, and as implied above, the SAFE structure has been around for a while, but the Y-Combinator information has some deal attorneys more jazzed about it again.

Some observers have noted that certain investor protections are not present in the Y-Combinator model. For example, information rights and the right to convert to equity earlier under certain circumstances are excluded. Deal attorneys say those are conditions that should be included in a SAFE.

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