One of the most thrilling and at the same time stressful activities a founder can undertake is raising money to start a new business. You have an idea, a solid team, and you require money to make it happen. You get to the early investors pretty soon and run into a legal obstacle: the contracts.
A contract that promises investors something in return for their early money is what you need before you even charge your company. The two most commonly used ones that you will come across are the SAFE (Simple Agreement for Future Equity) and the SAFT (Simple Agreement for Future Tokens).
Working on the legal side of dozens of seed rounds, the correct decision is often straightforward. However, choosing the incorrect one can lead to a huge, expensive mistake in the future.
In this guide, we will dissect what each contract is, the differences between them, and provide you with a straightforward answer on which contract fits best in the objectives of your startup.
Part 1: Why We Need Simple Contracts in the First Place
Consider a startup that is out of the idea stage. It lacks customers, no income, and possibly even a prototype of a product. How do you value that? A fair price, or valuation, of shares at such an early stage is virtually impossible.
Had you attempted to sell real shares today (a “priced round”), it would cost a huge sum of money and time to pay attorneys to determine the value, prepare lengthy, cumbersome documents, and address voting rights. It is a lengthy, costly process, and it deprives founders of the time to develop their business.
This is the reason why convertible instruments were developed. They are neither debts nor shares at this time. They are basic pledges that state: “Pay us money today, and when we launch our first big round of priced funding in the future, we give you shares at a special, better-than-everyone price.
SAFE and SAFT are both designed to accomplish this, yet they assure two things of very different kinds as the ultimate payoff.
Part 2: Breaking Down the SAFE Agreement (Future Equity)
Most early-stage tech companies follow the gold standard of the SAFE agreement. It was designed in 2013 by the well-known startup accelerator Y Combinator to streamline seed funding.
What is a SAFE?
SAFE stands for Simple Agreement for Future Equity.
The main concept is simple: A venture capitalist provides a startup with money now. In return, the investor receives the contractual right to receive the company equity (shares) at a discounted price in case of the occurrence of a large-scale event, which in most cases is the next big funding round (such as a Series A).
The Founder’s Benefit: No Debt, No Deadline
This is where the SAFE really comes in to shine among founders.
- It is Not Debt: A SAFE is not a loan, as is the case with the older convertible note. It is not recorded in your balance sheet as a debt. This makes your company clean financially.
- No Interest: The money invested by the investor does not earn interest. That is simply the dollar value of their investment, along with the privilege to be converted favorably later.
- No Maturity Date: There is no expiration date on a SAFE. In the event the firm needs five years to raise the next round, the SAFE simply sits there quietly. No time limit, so you have to pay the investor back or convert the funds.
These characteristics make the SAFE highly founder-friendly since it eliminates the time pressure that is ever-present and the risk of having to finance the investors if the next funding round gets stuck.
The Key Investor Protections
The SAFE is simple, but it does contain terms that may give the investor an incentive to take a massive risk on an early-stage company:
- Valuation Cap: This is the maximum value that the company may be worth at the time of the conversion of the SAFE. Assuming the company explodes and is worth $100 million in the future, the SAFE investor gets to buy shares as though the company were only worth the cap (e.g., $10 million). This makes early risk highly rewarded.
- Discount: This provides the investor with a discount (commonly 15 to 25 percent) on the price at which the new round of investors will purchase the shares. In case the subsequent investors invest 1 per share, the SAFE investor will just spend 0.75 or 0.85 per share.
Lawyer’s Insight: During my practice as a lawyer, I have been involved in closing SAFE agreements within days. They are generic, optic, and inexpensive relative to a custom convertible note or an equity round in legal costs. To a first-time founder, such simplicity is invaluable.
Part 3: Decoding the SAFT Agreement (Future Tokens)
The SAFT agreement is the creation of the blockchain and cryptocurrency industry. It became trendy a couple of years ago when startups were interested in raising funds on the basis of an electronic coin or token that they were to develop instead of the stock of the company.
What is a SAFT?
SAFT stands for Simple Agreement for Future Tokens.
The point of difference is obvious in the name: An investor puts money in the present to be able to obtain the tokens or other digital assets in the future, not the equity in the company (shares) in the future.
SAFTs are applied in situations where a startup is developing a decentralized network or product in which a native token is necessary to operate the system. The investor is gambling on the worth of such a token, rather than the conventional achievement and sale of the corporation.
The Token Trigger and Investor Risk
- The Trigger Event: A conversion of the company and the creation of the digital asset takes place when the company opens its network and establishes the digital asset, called the Token Generation Event (TGE). At this stage, the investor will get their promised tokens.
- Accredited Investors Only: Since the asset under sale (the right to a future token) is considered by regulators, particularly the SEC in the U.S., as a high-risk investment, SAFTs are nearly exclusively restricted to accredited investors only. These are the investors who qualify based on some high-income or net worth requirement. This seriously restricts the people who will invest in your company.
- No Equity Rights: In case the blockchain project changes its mind or decides that the network can operate without a token, the SAFT investor will own nothing in the company. Their contract does not grant them any right to the ownership of the company, just the token, which may or may not be drawn.
Lawyer’s Insight: The SAFT was aimed at attempting to put token sales into a securities-compliant box. The issue lies in the fact that regulators are yet to work out the regulations of digital assets. A plain SAFE has far less regulatory risk and burden compared to the SAFT. A SAFT should be avoided at all costs.
Part 4: The 4 Critical Differences Between SAFE and SAFT
Choosing the right contract comes down to four core distinctions.
1. The Asset You Promise
| Feature | SAFE (Future Equity) | SAFT (Future Tokens) |
| What the Investor Gets | Shares (Equity/Ownership) in the company. | Digital Tokens (Utility/Access) in the future network. |
| Success Defined By | Company acquisition, IPO, or big funding round. | Successful launch and adoption of the digital token/network. |
The Bottom Line: The Bottom Line: When your product is an application, a software, or a regular service, you are selling equity. Use a SAFE. When your business model is based solely on a coin or the decentralized protocol, then you are selling the token. Use a SAFT.
2. The Debt Status and Duration
A SAFE is clear: it is not debt, it does not have an interest, and it does not have to be repaid unless the company is dissolved. This makes the life of the founder much easier.
SAFTs also qualify as non-debt instruments, although they are typically more sophisticated in their payoff structure and may at times be structured along the lines of a convertible note, which may have more deadline or repayment negotiation. The simplicity of the SAFE template is usually lost in a SAFT.
3. The Regulatory Burden
This is the greatest challenge of SAFTs:
- SAFE: The legal framework is developed and popular in venture capital. Although legal advice is required, the underlying document is generic, and the potential of a regulatory problem is minimal with a normal tech startup.
- SAFT: The SAFT is continually under the scrutiny of the Securities and Exchange Commission (SEC). In selling a SAFT, you are selling a security in a private transaction. You need to adhere strictly to such rules as Regulation D in the U.S., which demands appropriate verification of the investor and legal filing. This implies additional legal costs, increased complexity, and increased long-term risk in the event that the token is considered an unregistered security.
4. The Investor Pool
SAFTs tend to limit your ability to access capital because they are considered to be securities:
- SAFTs generally require investors to be accredited. You would run a grave legal risk of taking small checks to your friends, family, or non-accredited individuals.
- SAFE agreements may be more open, according to the regulations you keep, and enable you to attract funds to a wider circle of individuals at an early stage.
Part 5: The Lawyer’s Simple Verdict on Which is Better
In 95% of startups, the decision is simple: The SAFE agreement is more effective.
It is more rapid, less expensive, uniform, and generally embraced by large-scale investors, as well as it does not have the regulatory grunge associated with promoting digital tokens. A SAFE should be used when you are developing a SaaS, a mobile app, or a hardware product.
When Might a SAFT Be Needed?
The SAFT should only be considered in the case:
- Your company is essentially a decentralized blockchain infrastructure where a utility-type token is the central asset, and not an equity one.
- You are undertaking a token-first approach in which the token will become the main generator of future value to investors.
- You have already hired the services of a specialist legal firm that can assist in the maze of digital asset securities regulations.
Unless you satisfy all three of these, do not use the SAFT. The risk and price are not worth the burden.
Founder Tip: Post-Money vs. Pre-Money SAFE
When you make a SAFE, you will also make a fateful decision: Pre-Money or Post-Money.
- Pre-Money SAFE: This was the earliest one. It determines the ownership of the investor, taking into consideration the valuation of the same before the conversion of the money. The disadvantage is that, in most cases, founders do not have any idea what percentage of the equity they are relinquishing until the next round.
- Post-Money SAFE: The latter is the newer and cleaner, and generally superior one. It determines the ownership of the SAFE holder by the post-money valuation of the owner.
Why Post-Money is Better: The Post-Money SAFE provides you with certainty as a founder. Before the next priced round, you can check out your cap table (the table of who owns what) and know precisely what percentage of the company you have sold to SAFE investors. Such transparency assists you in regulating your dilution, and this is a significant success in regulating the ownership of your company. Follow me on LinkedIn for more daily updates.
Conclusion
The decision in favor of a SAFE or a SAFT is not only a matter of selecting a document, but it is also the course of your company’s finances.
The SAFE is fast, easy, and conservative payoffs available in equity, so it is the tested fix to nearly any contemporary startup. Although the SAFT is an effort to have a compliant solution to the token economy, it poses significant regulatory risks and is only applicable to a niche of blockchain projects. Keep in mind that although an agreement is simple, a lawyer should always read the final terms. Should you wish to learn more about the Post-Money vs. Pre-Money SAFE, or perhaps you would like to see how valuation cap could impact your Series A dilution, then let me know. I would gladly consider those particular points in more detail.