With an increasing number of startups turning to cryptocurrency and blockchain-based fundraising methods, two prominent legal frameworks have emerged: the Simple Agreement for Future Tokens (SAFT) and the Simple Agreement for Future Equity (SAFE). Although both SAFT and SAFE aim to offer startups alternative financing options, they differ in legal structures and consequences for both the startup and the investor.
- Understanding SAFT:
A SAFT is a contract between a startup and an investor that gives the investor the right to receive tokens in the future once they are created and available for purchase. SAFT is commonly used by startups developing blockchain-based platforms and seeking capital through initial coin offerings (ICOs). Essentially, SAFT investors are buying the promise of future tokens rather than directly acquiring the tokens.
Advantages: SAFTs are suitable for blockchain startups raising capital through ICOs, allowing them to secure funds without immediate equity dilution. Investors may benefit from potential token value appreciation.
Considerations: ICO regulations can be complex and subject to change, making compliance crucial. The success of SAFTs depends on future token demand and value.
- Understanding SAFE (Simple Agreement for Future Equity):
A SAFE is a legal agreement between a startup and an investor that grants the investor the right to obtain equity in the startup at a later date, contingent on a specified event like a funding round or acquisition. SAFE is typically used by early-stage startups seeking financing. In a SAFE, investors essentially purchase the right to acquire equity once the startup reaches a predetermined milestone, rather than investing directly in equity.
Considerations: SAFEs typically do not provide immediate investor returns, and their value depends on the startup’s development.
Convertible Instruments: What Are They and How Do They Work?
Convertible instruments are relatively new financial tools introduced around 2005-2010 to simplify early-stage fundraising. They include instruments like the SAFE (developed by Y Combinator) and convertible notes (or convertible loan notes, developed by Techstars).
Two key concepts of convertible instruments:
Investor Receives Shares in the Next Investment Round: When a startup issues shares to a new investor in the next funding round, they must also issue shares to previous SAFE or convertible note investors during the current round.
Calculating Investor Shares: The primary task of convertible instruments is to calculate the number of shares that SAFE or convertible note investors receive in the next investment round, which can be a complex process for founders.
How SAFEs Work and Key Terms:
A SAFE is essentially an investor’s subscription to future shares of the company. They are used by early-stage startups not yet valued for traditional equity investments. Investors and the company agree on a discount rate or valuation cap for when equity is eventually purchased.
The goal of a SAFE is to ensure that when the startup raises a new round of investments at a new valuation, investors receive shares proportionate to their pre-seed investment. For example, if an investor contributes $200K at a $2M valuation, they get 10% of shares in the next round. Even if the valuation rises to $5M in the next round, the investor still receives 10% of shares. Conversely, if the startup’s valuation decreases, the investor gets a higher share proportionate to the decrease.
- Key Differences Between SAFT and SAFE:
Legal Structure: SAFT is considered a securities offering and is subject to securities laws and regulations, whereas SAFE is not categorized as a security and is exempt from these legal provisions.
Investor Rights: SAFT provides investors with the right to obtain tokens, while SAFE provides them with the right to acquire equity in the startup.
Payment: SAFT requires investors to pay for the right to receive tokens, whereas SAFE does not necessitate upfront payment.
Dilution: With SAFT, investors are shielded from dilution until tokens are created and sold, whereas with SAFE, investors’ equity can be diluted if the startup issues additional shares in a subsequent financing round.
- Choosing Between SAFT and SAFE:
The choice between SAFT and SAFE hinges on the specific needs and objectives of the startup. SAFT is better suited for blockchain startups aiming to raise capital via an ICO, while SAFE is more appropriate for startups seeking funding during their seed or early-stage rounds. Both frameworks offer distinct advantages and drawbacks, necessitating careful consideration by startups and investors. Consulting legal and financial experts is advisable before making a decision.
In conclusion, SAFT and SAFE are two prominent legal frameworks providing startups with alternatives to traditional financing methods. While they diverge in legal structures and consequences, they each offer unique benefits that can foster growth and success. As with any investment or legal agreement, thorough due diligence and professional guidance are essential when making decisions.
In addition to their legal distinctions, both SAFT and SAFE offer distinct advantages and considerations for startups and investors:
This website is intended solely for informational purposes and does not constitute legal advice. You should not rely on the information presented here and should consult a lawyer for professional advice tailored to your specific situation. No solicitor-client relationship with TIMELAW is established until a formal written agreement is in place.