Uncapped SAFEs: when to use them, no cap

Jason Yeh
September 13, 2022

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A founder asked me the other day “are there any problems with uncapped SAFEs?”

The short answer is yes, absolutely. The more accurate response requires some nuance, so I told him he’d get his answer in my next post.

First - what’s a SAFE? 

A SAFE is a Simple Agreement for Future Equity. SAFEs, as I've described in the past, are a way to take on investment dollars with fewer legal requirements and documentation (and in turn less time and money) than a traditional equity round. 

When you invest in a SAFE, you technically do not own equity (the thing that could be sold for actual dollars/profit down the road) until a future round of funding is raised. The SAFE says that when the equity round is raised, the SAFE investment converts into equity at some agreed upon terms.  Those terms usually include a VALUATION CAP and a DISCOUNT which determine what price is used to calculate the amount of equity an investor gets. 

The valuation cap and discount are there to address two scenarios:

  1. The value of the company going up
  2. The value of the company going down

Take the hypothetical situation of a company raising money using a SAFE with a $10MM pre-money valuation cap and a 20% discount.

The $10MM valuation cap defines the highest value that can be used to calculate the conversion of a SAFE investment. So, if the company goes up after the investment is made, the investor will convert at the valuation cap. For all intents and purposes, a valuation cap is essentially a proxy for valuing the company today. In other words, it would be like the investor negotiated an equity investment where the company was valued at $10MM.

The discount addresses the second scenario of the company value going down after the investment. So in this situation, if the company raises its next equity round at a price that's below $10MM, then the investment would convert at a price that is 20% lower than whatever equity round gets negotiated. 

FUN FACT: For the past 5 years, the discount was considered a strange component of SAFEs that were included out of tradition. They never really came into play because companies would either raise money at higher valuations or go out of business. There was really no in between. We’re about to see them finally get their time to shine (not actually a good thing…).  With SO many companies raising money on SAFEs with astronomical valuation caps over the last 2 years, there will be tons of companies forced to raise money at valuations below the last cap…

So at that valuation cap of $10MM, if the company raised its next round at a $5 million valuation, SAFE investors would convert at a $4MM price ( 20% lower $5MM). 

Again…what is an uncapped SAFE?? 

Now that you have the background, I can drop the no cap knowledge (awesome incorporation of slang, amirite?). An uncapped SAFE as you might expect from its name, is a SAFE without a valuation cap 🚫🧢. Without a cap, the only feature that determines the conversion price of a SAFE is a discount.  That means whether the value of the company goes up or down, an investor always converts at a discount to the next round valuation…no cap :).

Why uncapped SAFEs? 

For founders, it lets you avoid the time and brain damage that comes from setting a valuation.  Negotiations can be uncomfortable and there are some situations where it could be helpful to avoid revealing your valuation to the market.

The bigger value to the founder occurs if they can use the money invested on an uncapped SAFE to grow the value of the company tremendously.  Remember, even if the company skyrockets in value, the investor just gets a set discount…again, no cap. 

Here’s the money scenario for founders - let’s say you raised money for your company today when most people think it’s worth $10MM but instead of raising it using a SAFE with a $10MM cap, you got investors to agree to an uncapped SAFE with a 20% discount. If after that you grow the company where VCs want to invest at $100MM, even though the SAFE investors put money in when the company was probably only worth $10MM, they are going to convert at $80 million, just a 20% discount into that next round. 

That exact situation is why experienced investors HATE uncapped SAFEs. When founders started using uncapped convertible notes (the convertible note was the predecessor to the SAFE) in the early 2010’s, investors had no spidey sense warning them against them until most of them got burnt at least once. At Greycroft, we were the first check into a company which would grow into a massive company…but invested in an uncapped note.  Still a win but maybe 3-5x less of a win! I haven’t been able to take an uncapped SAFE seriously since then…

By the way, this is how most investors develop specific things they will “never do.” They make mistakes that they vow never to do again!

Wait, so never uncapped SAFEs?

Does that mean an uncapped SAFE is never a good idea? Not never, but very rarelyfew.

The main situation where an uncapped SAFE is the right choice for both investors and founders one is when the investment is coming JUST BEFORE an equity round. The situation is a round is going to happen very soon, but you either need to, want to, or are being convinced to jam in some money ahead of that fundraise.

If that round is impending and investors are confident that it will happen in a short amount of time, then an investor can feel comfortable that their dollars are not going into the company to finance an extended period of time when the valuation could rise significantly.  An investor should only invest in an uncapped SAFE if they believe they will be compensated fairly with the discount. 

Alternatives to uncapped SAFEs, no cap 

Don’t be lazy. Look for a fair middle ground.  

*Set a cap. 

One final note regarding this takeaway. I acknowledge that investors have the upper hand in negotiations. They do it more and they have more data so they will be better. 

With a little bit of reading, coaching, and practice around negotiations… plus some research into current market valuations, founders can close the gap.  

I’m confident that setting a cap for a SAFE is the best approach for founders.

*(i almost said “set a cap no cap” as in “set a cap. i’m not kidding”. That would’ve been hilarious …but to 5% of my readers)

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