How are seed investors in a SAFE protected from a venture capital recap?

SAFEs are actually surprisingly investor-friendly in several ways.

They are very founder-friendly in that they transfer no ownership, votes, or other “say” in the business initially. Investors have almost no rights at all until those SAFEs convert. SAFEs are also possibly founder-friendly in that they are easy to use.

However, SAFEs do have significant investor protections in their standard form, at least:

  • First, SAFEs have medium-strong anti-dilution protection. More than most founders realize, and more than typical equity documents. No matter how much you raise later, the pre-money (and sometimes, the post-money) in capped SAFEs is fixed/capped. If you raise equity instead, the prior investors generally share more of the dilution from subsequent fundraising at a “comparable” valuation. This most really only matters if you raise multiple rounds of SAFEs, but if you do, the impact of the anti-dilution protections sneak up on you. Also, SAFEs provide implicit 100% antidilution protection to increases in the option pool and common stock issuances prior to their conversion that equity doesn’t. The bottom line is an investor will typically get a “better” deal at a $7m cap today, than investing in a $7m pre equity round today, if you raise more funds prior to conversion. The difference may be modest, but it’s often real.
  • Second, the rights under standard SAFEs require a majority-in-interest to waive. That’s what you are getting at. So it’s fairly complicated to “recap” SAFEs with many small investors. It’s fairly easy to “recap” SAFEs only if 50.1% of the investors want to go along.

When a recap has to happen (and I hope it never does for you), it’s often actually much harder with 20+ SAFE or Convertible Debt holders than 1–2 significant equity holders. You have to corral so many of them to agree. You may prefer that as an angel, but as a founder, it can be a real issue.

>> SAFEs work best when you never really have to go back to your SAFE investors and ask for anything. <<

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Published on January 21, 2019

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