Introduction of Simple Agreement for Future Equity
This refers to a scenario where two parties come into an agreement which includes the investor or customer and the company or the organization which issues certain rights to the customer or the investor for having future equity in the organization, which is as same as a warrant, which is followed by an exception that the prices of per share would not be pre-determined when the initial investment takes place.
The investor who is a part of such agreement of SAFE is obliged to get the future shares at the time when the price round of the investment or fluidity event occurs. It refers to an investment in cash, an interchange that allows the customer or investor to change their investment into future equity.
Let me clear a very important area in SAFE that it is not termed as a loan, and hence it does not include interest payments and maturity dates. It is not equity, neither it is a common nor a preferred stock, which also disables them to provide any rights of voting and other rights related to equity under the state laws. The investing person invests the cash, followed by the company, which signs a contract that gives the investor authority to some of the rights.
Mechanics or including terms in the investment.
SAFE investments include three main terms that need to be negotiated: that is valuation cap, triggering events, and discount. After getting these terms, the investors and the company can lose or make a lot of money.
Let’s understand and reveal the expressions.
- Valuation cap: A beginner investor in the early days takes enough risk; hence the particular risk isn't rewarded in case all the capitalists are getting or is liable to get the right for investment with the other companies are more valuable, and more likely valuation cap helps to overcome this problem.
It works by setting the company's highest value for checking or knowing the percentage of equity the investor would get. In the absence of a valuation cap, the equity percentage in respect to the SAFE investor gradually keeps on decreasing as there is an increase in the company's value.
- Triggering events – SAFE's are converted into equity when admitted to the "triggering events". The SAFE's becomes worthless if the organization goes bust or if the triggering events don't take place.
- Discount Rate- As the term suggests, it offers a rebate to the SAFE investors on the price which future investors would be paying for equity in the period of triggering event.
Need of Simple Agreement for Future Equity:
SAFE's matter a lot for start-ups, which helps them raise money for their organization.
It is mainly used as
- simple for creating and implementing purposes.
- It doesn't accrue interest as such as a loan.
- It offers flexible enhancements in raising funds for the company.
These points are appealing and attract customers to the company who are ready for investment.
They also have the quality of less risk, which invites other investments too.
Few problems that SAFE solves are:
Paper-based work- They are time-consuming and even require a lot of energy, which turns out to be a complication for the start-ups since their time and energy requires to be in scaling up the growth of the company, and their operational staff.
Debt- Financial obligation is an issue for the starting companies who are just trying to gain stability in the market; it can be stressful and bring the company to an end. It can make the start-ups see the face of failure and, hence, get shut down.
Standardization- The standardized agreements become burdensome as they thrust specific terms and require some specific standards. The best part of being an organization standardized is that it provides expectation and consistency, but on the other part it restricts customization.
Legal Costs- Start-ups are required for lawful direction and advice, which would help them act according to all the rules and regulations that would be appropriate for their goods, services, and industry.
Control- The customers investing in the company, mainly in start-ups, want to have control in the shaping of the company for as much as possible to make sure that their sight comes in real as their thoughts, which becomes problematic as control is distributed among more and more people.
As we move forward, let us understand and see the differences to other types or forms of raising capital.
|Basis of difference||SAFE||CONVERTIBLE NOTE||EQUITY||DEBT ( LOAN)|
|Generally, the need does not persist, but at times it is involved.||Normally the use is not mentioned, but involvement occurs at times.||Pre and post-cash evaluations are positioned for a particular round.||It only becomes important for security purposes or the provision of a loan; hence no valuation is needed.|
|It is fast and gets easily negotiated.||In comparison to SAFE, more negotiation is included of the debt-related elements.||It takes extra time and tuff to negotiate.||Negotiation spaces are less in this since protections of tuff lenders are included.|
||Only safe docs.||Only convertible notes.||Deed of subscription, agreement of shareholders, moreover share certificate.||Agreement of security and loan.|
||Regulated by Corporations Act.||Regulated by Corporations Act as a debt element.||Regulated by Corporations Act.||Regulation takes place as a debt element or instrument.|
||Not applicable.||Inclusion can exist, but a requirement is not there.||Not applicable.||Always required and utmost included.|
All these statements are helpful for readers to understand what are the advantages or disadvantages and make a firm decision whether to go for investment purposes or not.
SAFE's are very easy and fast in terms of negotiation; there is no inclusion of pre-money evaluation purposes. The parameters under which SAFE's are negotiated are
- Security permissions regarding loans for the start-ups.
- The interest of the founders whether they should invest or not.
- Tenure and terms of the loan.
SAFE has already gained an ample amount of interest in India as well as other countries, yet start-ups are still hesitant towards approaching and moving with it. People who are investing need time to get familiar with the elements and therefore invest.
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