Planning to raise money? Make sure you’re ‘Safe’

Back in 2013, the Y Combinator (YC), a top Silicon Valley seed accelerator, introduced the Simple Agreement for Future Equity (Safe), which has been widely used by startups and investors all over the world for early stage fundraising.

What is a Safe? It’s a financial instrument that simplifies seed investment by serving as a right to purchase shares in a future priced round, subject to certain parameters set in advance. Safe does not have a maturity date nor an interest (profit) rate, as it is neither a debt nor equity. It should be simpler, quicker and cheaper than the priced equity round.

Due to the wide acceptance of the Safe, startups started to raise more Safe rounds as each independent round (as opposed to using it as a “bridge round”). This made it difficult for the founders and investors to keep track of their relative ownerships. YC, conscious of the voice raised by the startup ecosystem, introduced the new post-money valuation cap Safe in late-2018.

Here are three reasons why, at Shorooq Partners, we have decided to adopt PostMoney Safe for our early-stage investments. Clear tracking of ownership and dilution: Post-Money

Safe, as its name implies, works with a post-money valuation, which is the valuation immediately after (1) all of the Safe investments until the priced equity round (commonly Series A in the region); (2) the option pool created or increased as part of the Safe rounds (but prior to the equity financing).

Given the Post-Money Valuation Cap, Safes are no longer diluted by each other nor by the options granted or created from the subsequent Safe rounds (but prior to an equity financing). Therefore, investors and founders can accurately track ownership and dilution changes they will get with their investment. For example, a $1 million seed raise at a post-money caluation cap of $5 million would give 20 per cent ownership to Seed Safe investors regardless to the startup raising another Safe round(s) in a future date, only to be diluted by Series A.

Pro-rata rights: In Pre-Money Safe, prorata rights are a default component — these rights are held by Safe investors to participate in a subsequent round to maintain their percentage ownership, and are applied to the financing after the round in which the Safe converted to shares (or at least this was the original intention yet we apply this differently in the Middle East as it has become a norm to invest pro-rata before the Safe conversion into shares).

In Post-Money Safe, pro-rata rights are no longer included as default and must be affirmatively granted to the investor, by entering into a standardised side letter that grants such rights and applies to the round in which the Safe converts. In the writer’s perspective, despite the extra work to create the side letter, it is benefit to the founders as they can decide which strategic investors to give the pro-rata rights versus everyone.

Safe amendments: The Pre-Money Safe can only be amended under the written consent of the investor, whereas Post-Money Safe can be amended upon majority of Safe holders’ consent. This change allows the founders and the investors to amend the Safe for all Safe holders in a more practical and functional manner.

There are other reasons that make PostMoney Safe an essential financing security for both founders and investors, and we believe that this will further accelerate the current explosive growth of the startup ecosystem in the UAE, Middle East and beyond.

“Post-Money Safe will further accelerate the current explosive growth of the startup ecosystem in the UAE”

SHANE SHIN is managing partner at Shorooq Partners. Views expressed are his own and do not reflect the newspaper’s policy.