Tl;dr: SAFE MFN (Most Favoured Nation) version of the Y-combinator post-money SAFE financing document explained line by line explanation.
If you are planning on raising an angel/seed round with a new post-money SAFE you need to know what is in the legal agreement. You aren’t a lawyer, so I’m going to explain the whole document in simple English.
I’m going to cover each of the 5 documents that Y-Combinator offer. If you are going to use another one, you can link to the right blog here:
- Safe: Valuation Cap, no Discount
- Safe: Discount, no Valuation Cap
- Safe: Valuation Cap and Discount
- Safe: MFN, no Valuation Cap, no Discount
- Pro Rata Side Letter
All quotes are the exact wording of the SAFE documents. Everything else are my comments. For idiots, this is not legal advice, I take no responsibility for any losses, get a lawyer, yada yada.
For syntax, I’m going to assume you raise at a series-A. That’s the word for the qualified financing round I am going to use.
Note: there are a number of places where there are numbers involved. I’m not going to nerd out here on how the math is done. Instead, I made a model with the math done. Download the model and you can see how the math is done. You can read the blog here.
Download the SAFE model
THIS INSTRUMENT AND ANY SECURITIES ISSUABLE PURSUANT HERETO HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), OR UNDER THE SECURITIES LAWS OF CERTAIN STATES. THESE SECURITIES MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED, PLEDGED OR HYPOTHECATED EXCEPT AS PERMITTED IN THIS SAFE AND UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT OR AN EXEMPTION THEREFROM.
This is a warning to investors. It’s boring. You don’t care.
It basically says that only sophisticated investors can and should invest in startup land and they can’t sell off their investment to other people.
Company name in the SAFE MFN
You need to input your legal name. It’s one of only 5 fields other than signature stuff you need to fill in.
How much the investor is investing in the SAFE MFN
(Simple Agreement for Future Equity)
THIS CERTIFIES THAT in exchange for the payment by [Investor Name] (the “Investor”) of $[_____________] (the “Purchase Amount”) on or about [Date of Safe], [Company Name], a [State of Incorporation] corporation (the “Company”), issues to the Investor the right to certain shares of the Company’s Capital Stock, subject to the terms described below.
You need to input:
- The investor name. E.g. Sequoia
- The amount in Dollars the investor is investing. E.g. $200,000
- The date you are signing this document and it comes into effect. E.g. 1 January 2020
- Your company name. E.g. Uber
- The state you are incorporated in. E.g. Delaware
This says that for an investment in the SAFE, the investor gets shares in your company as will be set out in a minute.
Don’t change the SAFE MFN document
This Safe is one of the forms available at https://ycombinator.com/documents and the Company and the Investor agree that neither one has modified the form, except to fill in blanks and bracketed terms.
The new post-money SAFE makes an effort to say that no one can change the document other than in the brackets. The goal is to restrict changes so you don’t need a lawyer. Everyone knows it is the same. If everyone is ok with the SAFE in principle, there are no other changes to make. There is no funny business!
(a) Equity Financing. If there is an Equity Financing before the termination of this Safe, on the initial closing of such Equity Financing, this Safe will automatically convert into the number of shares of Standard Preferred Stock equal to the Purchase Amount divided by the lowest price per share of the Standard Preferred Stock.
Equity financing means the series-A round. The number of shares that the investor gets is just how much they invested divided by the same price that the series-a investors pay, or what anyone else pays, if lower, assuming there is another SAFE which converts into Standard Preferred Stock at the same time. There is no discount or cap built into this version.
In connection with the automatic conversion of this Safe into shares of Standard Preferred Stock, the Investor will execute and deliver to the Company all of the transaction documents related to the Equity Financing; provided, that such documents are the same documents to be entered into with the purchasers of Standard Preferred Stock, and provided further, that such documents have customary exceptions to any drag-along applicable to the Investor, including, without limitation, limited representations and warranties and limited liability and indemnification obligations on the part of the Investor.
SAFE investors will get and sign the same docs as series-a investors.
The next part says the docs will have “customary exceptions” to the “drag along” provisions. Customary exceptions relate to bankruptcy, insolvency, reorganization or other similar provisions affecting creditors’ rights generally.
This is written differently to all the variations of this document. In the cap only version for example, the SAFE can convert into “Standard Preferred Stock or Safe Preferred Stock”. In this case the MFN only SAFE does not convert into Safe Preferred Stock.
(b) Liquidity Event. If there is a Liquidity Event before the termination of this Safe, this Safe will automatically be entitled to receive a portion of Proceeds, due and payable to the Investor immediately prior to, or concurrent with, the consummation of such Liquidity Event, equal to the greater of (i) the Purchase Amount (the “Cash-Out Amount”) or (ii) the amount payable on the number of shares of Common Stock equal to the Purchase Amount divided by the Liquidity Price (the “Conversion Amount”). If any of the Company’s securityholders are given a choice as to the form and amount of Proceeds to be received in a Liquidity Event, the Investor will be given the same choice, provided that the Investor may not choose to receive a form of consideration that the Investor would be ineligible to receive as a result of the Investor’s failure to satisfy any requirement or limitation generally applicable to the Company’s securityholders, or under any applicable laws.
Liquidity event means that you sell the company. This section tells you how SAFE investors get paid out if you exit before you have a series-a. They get either:
- The amount they invested
- The amount they would get if they converted to shares. Liquidity price and capitalization are defined later.
The final part is about being treated fairly. If other investors get a choice of how they are paid, they get the same choice, unless that would violate some law.
Notwithstanding the foregoing, in connection with a Change of Control intended to qualify as a tax-free reorganization, the Company may reduce the cash portion of Proceeds payable to the Investor by the amount determined by its board of directors in good faith for such Change of Control to qualify as a tax-free reorganization for U.S. federal income tax purposes, provided that such reduction (A) does not reduce the total Proceeds payable to such Investor and (B) is applied in the same manner and on a pro rata basis to all securityholders who have equal priority to the Investor under Section 1(d).
This is an edge case. If the company changes its structure (Section 368(A)(1) outlines a format for tax treatment to reorganizations) due to an acquisition or something, the SAFE investors don’t get disadvantaged. They are happy for money to be spent so long as the SAFE investor gets what they are owed and that everyone with the same ranking get treated the same way. Section 1(d) the “liquidity priority” is defined later. This is nerdy stuff you don’t’ really need to know about as you will definitely have a lawyer deal with it.
(c) Dissolution Event. If there is a Dissolution Event before the termination of this Safe, the Investor will automatically be entitled to receive a portion of Proceeds equal to the Cash-Out Amount, due and payable to the Investor immediately prior to the consummation of the Dissolution Event.
If the company is shut down (dissolves) before the series-a, the SAFE investors will get what they invested (cash-out amount) in proportion to whatever is left. More than likely there will be nothing! But if there is something they get it before you close the company.
(d) Liquidation Priority. In a Liquidity Event or Dissolution Event, this Safe is intended to operate like standard non-participating Preferred Stock. The Investor’s right to receive its Cash-Out Amount is:
If you sell or shut down the company, the SAFE MFN investor gets only their money back. Participating preferred means your money plus what you get if you convert to stock. They then explain the order of how people are paid back.
(i) Junior to payment of outstanding indebtedness and creditor claims, including contractual claims for payment and convertible promissory notes (to the extent such convertible promissory notes are not actually or notionally converted into Capital Stock);
Junior means they get paid after anyone who is senior.
SAFE MFN are junior to general creditors and convertible notes (so long as they remain the debt bit and don’t convert to equity).
(ii) On par with payments for other Safes and/or Preferred Stock, and if the applicable Proceeds are insufficient to permit full payments to the Investor and such other Safes and/or Preferred Stock, the applicable Proceeds will be distributed pro rata to the Investor and such other Safes and/or Preferred Stock in proportion to the full payments that would otherwise be due; and
They have an equal right to receive what money is left after debt/creditors are paid to other SAFE MFN investors and preference investors. Every one of the same level gets a proportional share.
(iii) Senior to payments for Common Stock.
The Investor’s right to receive its Conversion Amount is (A) on par with payments for Common Stock and other Safes and/or Preferred Stock who are also receiving Conversion Amounts or Proceeds on a similar as-converted to Common Stock basis, and (B) junior to payments described in clauses (i) and (ii) above (in the latter case, to the extent such payments are Cash-Out Amounts or similar liquidation preferences).
SAFE MFN rank above people who have common stock. That means founders and staff. So founders and staff are the last to get any money!
- SAFE MFN rank if there is a conversion to stock happening, so other SAFEs
- Rank above what we talked about already (basically repeating itself)
(e) Termination. This Safe will automatically terminate (without relieving the Company of any obligations arising from a prior breach of or non-compliance with this Safe) immediately following the earliest to occur of: (i) the issuance of Capital Stock to the Investor pursuant to the automatic conversion of this Safe under Section 1(a); or (ii) the payment, or setting aside for payment, of amounts due the Investor pursuant to Section 1(b) or Section 1(c).
Termination of the SAFE MFN has been mentioned a few times. Now it is defined. The SAFE MFN will last forever unless it terminates when the investor is either
- Issued series-a shares, or
- Gets paid cash in a few scenarios.
Now we are at the definitions section.
“Capital Stock” means the capital stock of the Company, including, without limitation, the “Common Stock” and the “Preferred Stock.”
Just defines all the shares you might have.
“Change of Control” means (i) a transaction or series of related transactions in which any “person” or “group” (within the meaning of Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), becomes the “beneficial owner” (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended), directly or indirectly, of more than 50% of the outstanding voting securities of the Company having the right to vote for the election of members of the Company’s board of directors, (ii) any reorganization, merger or consolidation of the Company, other than a transaction or series of related transactions in which the holders of the voting securities of the Company outstanding immediately prior to such transaction or series of related transactions retain, immediately after such transaction or series of related transactions, at least a majority of the total voting power represented by the outstanding voting securities of the Company or such other surviving or resulting entity or (iii) a sale, lease or other disposition of all or substantially all of the assets of the Company.
Change of control generally means you sell the company- typically when you sell more than 50%. This is referenced when we talked about a liquidity event above. Most of this is legalise.
“Dissolution Event” means (i) a voluntary termination of operations, (ii) a general assignment for the benefit of the Company’s creditors or (iii) any other liquidation, dissolution or winding up of the Company (excluding a Liquidity Event), whether voluntary or involuntary.
Dissolution is shutting down the company as I mentioned before. There are reasons for this:
- You decide to shut down (You need the board to approve)
- You have to do it to make people you owe money happy
- Whatever reason to shut down (Other than selling the company)
Voluntary means you choose to, involuntary means you are made to.
“Dividend Amount” means, with respect to any date on which the Company pays a dividend on its outstanding Common Stock, the amount of such dividend that is paid per share of Common Stock multiplied by (x) the Purchase Amount divided by (y) the Liquidity Price (treating the dividend date as a Liquidity Event solely for purposes of calculating such Liquidity Price).
Dividends is you making so much cash that you don’t know how to spend it properly to grow the company so you pay it out in cash. If you do pay out a dividend, then they define how much money the SAFE investor gets.
“Equity Financing” means a bona fide transaction or series of transactions with the principal purpose of raising capital, pursuant to which the Company issues and sells Preferred Stock at a fixed valuation, including but not limited to, a pre-money or post-money valuation.
The series-a is only a real round if you are raising money and issue preference shares. This doesn’t apply if the series-a is convertible. It also doesn’t matter if the valuation is based on pre or post-money.
“Initial Public Offering” means the closing of the Company’s first firm commitment underwritten initial public offering of Common Stock pursuant to a registration statement filed under the Securities Act.
You do an IPO. Simple.
“Liquidity Event” means a Change of Control or an Initial Public Offering.
Your startup makes money by selling 50%+ or an IPO.
“Liquidity Price” means the fair market value of the Common Stock at the time of the applicable Liquidity Event (determined by reference to the purchase price payable in connection with such Liquidity Event).
The price the SAFE MFN investor pays is that the series-a investors pay.
“Proceeds” means cash and other assets (including without limitation stock consideration) that are proceeds from the Liquidity Event or the Dissolution Event, as applicable, and legally available for distribution.
Proceeds are money you make if you sell. It’s cash, bitches!
“Safe” means an instrument containing a future right to shares of Capital Stock, similar in form and content to this instrument, purchased by investors for the purpose of funding the Company’s business operations. References to “this Safe” mean this specific instrument.
They define the SAFE MFN for shites and giggles.
“Standard Preferred Stock” means the shares of the series of Preferred Stock issued to the investors investing new money in the Company in connection with the initial closing of the Equity Financing.
These are the shares that the series-a investors get.
“Subsequent Convertible Securities” means convertible securities that the Company may issue after the issuance of this instrument with the principal purpose of raising capital, including but not limited to, other Safes, convertible debt instruments and other convertible securities. Subsequent Convertible Securities excludes: (i) options issued pursuant to any equity incentive or similar plan of the Company; (ii) convertible securities issued or issuable to (A) banks, equipment lessors, financial institutions or other persons engaged in the business of making loans pursuant to a debt financing or commercial leasing or (B) suppliers or third party service providers in connection with the provision of goods or services pursuant to transactions; and (iii) convertible securities issued or issuable in connection with sponsored research, collaboration, technology license, development, OEM, marketing or other similar agreements or strategic partnerships.
The Subsequent Convertible Securities are any notes you might issue to raise more money. It includes any kind of instrument which is convertible (meaning not your series-a). It doesn’t include:
- Options issued to staff
- Notes issued to debt financers (Typically this means venture debt), people who do work in exchange for a convertible (Like web developer house)
- Anything related to strategic partnerships
The point being that SubsequentConvertible Securities are strictly defined as those used expressly for fundraising. This means you can give better deals in exchange for a partnership etc.
3. “MFN” Amendment Provision. If the Company issues any Subsequent Convertible Securities prior to termination of this Safe, the Company will promptly provide the Investor with written notice thereof, together with a copy of all documentation relating to such Subsequent Convertible Securities and, upon written request of the Investor, any additional information related to such Subsequent Convertible Securities as may be reasonably requested by the Investor. In the event the Investor determines that the terms of the Subsequent Convertible Securities are preferable to the terms of this instrument, the Investor will notify the Company in writing. Promptly after receipt of such written notice from the Investor, the Company agrees to amend and restate this instrument to be identical to the instrument(s) evidencing the Subsequent Convertible Securities.
Now the SAFE MFN thing kicks in. This means Most Favoured Nation. This means you get the best terms of the Subsequent Convertible Securities we just talked about.
When you issue a new convertible you will tell the SAFE MFN investor and provide them with any information that is pertinent to the financing so that they are informed as to what the terms you agreed with the new investors are.
If you give terms which are “preferable to the terms of this instrument” the SAFE MFN investor will tell the founder. Then the founder basically gives the SAFE MFN the same legal document that the new investor got.
- Company Representations
(a) The Company is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation, and has the power and authority to own, lease and operate its properties and carry on its business as now conducted.
Your company is kosher. Investors don’t want any shady shite. You have filed all the required incorporation paperwork with the Secretary of State of the state you are incorporated in. Delaware is the place most investors have expected you to have filed in (Stripe Atlas help with this).
(b) The execution, delivery and performance by the Company of this Safe is within the power of the Company and has been duly authorized by all necessary actions on the part of the Company (subject to section 3(d)). This Safe constitutes a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or affecting the enforcement of creditors’ rights generally and general principles of equity. To its knowledge, the Company is not in violation of (i) its current certificate of incorporation or bylaws, (ii) any material statute, rule or regulation applicable to the Company or (iii) any material debt or contract to which the Company is a party or by which it is bound, where, in each case, such violation or default, individually, or together with all such violations or defaults, could reasonably be expected to have a material adverse effect on the Company.
You and your board of directors have approved the SAFE MFN so it’s not shady! The docs have been changed and the board approved. Boring legal stuff.
(c) The performance and consummation of the transactions contemplated by this Safe do not and will not: (i) violate any material judgment, statute, rule or regulation applicable to the Company; (ii) result in the acceleration of any material debt or contract to which the Company is a party or by which it is bound; or (iii) result in the creation or imposition of any lien on any property, asset or revenue of the Company or the suspension, forfeiture, or nonrenewal of any material permit, license or authorization applicable to the Company, its business or operations.
Issuing the SAFE MFN is Kool and the Gang! The startup has no issue in issuing the SAFE to investors.
(d) No consents or approvals are required in connection with the performance of this Safe, other than: (i) the Company’s corporate approvals; (ii) any qualifications or filings under applicable securities laws; and (iii) necessary corporate approvals for the authorization of Capital Stock issuable pursuant to Section 1.
The startup doesn’t need to get any special approval to issue this SAFE MFN.
(e) To its knowledge, the Company owns or possesses (or can obtain on commercially reasonable terms) sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, processes and other intellectual property rights necessary for its business as now conducted and as currently proposed to be conducted, without any conflict with, or infringement of the rights of, others.
Your startup doesn’t have any major IP issues. You aren’t going to create legal issues.
- Investor Representations
Investors assure everything is true.
(a) The Investor has full legal capacity, power and authority to execute and deliver this Safe and to perform its obligations hereunder. This Safe constitutes valid and binding obligation of the Investor, enforceable in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or affecting the enforcement of creditors’ rights generally and general principles of equity.
Investors are allowed to invest. They are allowed to sign for things.
(b) The Investor is an accredited investor as such term is defined in Rule 501 of Regulation D under the Securities Act, and acknowledges and agrees that if not an accredited investor at the time of an Equity Financing, the Company may void this Safe and return the Purchase Amount. The Investor has been advised that this Safe and the underlying securities have not been registered under the Securities Act, or any state securities laws and, therefore, cannot be resold unless they are registered under the Securities Act and applicable state securities laws or unless an exemption from such registration requirements is available. The Investor is purchasing this Safe and the securities to be acquired by the Investor hereunder for its own account for investment, not as a nominee or agent, and not with a view to, or for resale in connection with, the distribution thereof, and the Investor has no present intention of selling, granting any participation in, or otherwise distributing the same. The Investor has such knowledge and experience in financial and business matters that the Investor is capable of evaluating the merits and risks of such investment, is able to incur a complete loss of such investment without impairing the Investor’s financial condition and is able to bear the economic risk of such investment for an indefinite period of time.
This is a typical American thing to make sure that investors are rich and not dumb. An accredited investor is someone who is rich enough to lose money.
- Net worth of over $1 million (excluding house)
- Income exceeds $200k for the last two years, or
- Joint annual income with wife is larger than $300k for the last two years.
(a)Any provision of this Safe may be amended, waived or modified by written consent of the Company and either (i) the Investor or (ii) the majority-in-interest of all then-outstanding Safes with the same “Post-Money Valuation Cap” and “Discount Rate” as this Safe (and Safes lacking one or both of such terms will be considered to be the same with respect to such term(s)), provided that with respect to clause (ii): (A) the Purchase Amount may not be amended, waived or modified in this manner, (B) the consent of the Investor and each holder of such Safes must be solicited (even if not obtained), and (C) such amendment, waiver or modification treats all such holders in the same manner. “Majority-in-interest” refers to the holders of the applicable group of Safes whose Safes have a total Purchase Amount greater than 50% of the total Purchase Amount of all of such applicable group of Safes.
Terms can be changed, but you can’t change the terms of the SAFE MFN with an email at 5am after a party. You need the majority of investors to change terms, which is more than 50% of the investors.
(b) Any notice required or permitted by this Safe will be deemed sufficient when delivered personally or by overnight courier or sent by email to the relevant address listed on the signature page, or 48 hours after being deposited in the U.S. mail as certified or registered mail with postage prepaid, addressed to the party to be notified at such party’s address listed on the signature page, as subsequently modified by written notice.
You can send important notices by email or even snail mail.
(c) The Investor is not entitled, as a holder of this Safe, to vote or be deemed a holder of Capital Stock for any purpose other than tax purposes, nor will anything in this Safe be construed to confer on the Investor, as such, any rights of a Company stockholder or rights to vote for the election of directors or on any matter submitted to Company stockholders, or to give or withhold consent to any corporate action or to receive notice of meetings, until shares have been issued on the terms described in Section 1. However, if the Company pays a dividend on outstanding shares of Common Stock (that is not payable in shares of Common Stock) while this Safe is outstanding, the Company will pay the Dividend Amount to the Investor at the same time.
If you invested in a SAFE, then you don’t have rights as a shareholder until you convert into shares.
(d) Neither this Safe nor the rights in this Safe are transferable or assignable, by operation of law or otherwise, by either party without the prior written consent of the other; provided, however, that this Safe and/or its rights may be assigned without the Company’s consent by the Investor to any other entity who directly or indirectly, controls, is controlled by or is under common control with the Investor, including, without limitation, any general partner, managing member, officer or director of the Investor, or any venture capital fund now or hereafter existing which is controlled by one or more general partners or managing members of, or shares the same management company with, the Investor; and provided, further, that the Company may assign this Safe in whole, without the consent of the Investor, in connection with a reincorporation to change the Company’s domicile.
If you invest in a SAFE MFN you can’t sell it to someone else. As a startup, you can’t sell the SAFE MFN to someone else either.
(e) In the event any one or more of the provisions of this Safe is for any reason held to be invalid, illegal or unenforceable, in whole or in part or in any respect, or in the event that any one or more of the provisions of this Safe operate or would prospectively operate to invalidate this Safe, then and in any such event, such provision(s) only will be deemed null and void and will not affect any other provision of this Safe and the remaining provisions of this Safe will remain operative and in full force and effect and will not be affected, prejudiced, or disturbed thereby.
This is about ‘severability’. If any clause doesn’t stand up, it doesn’t make the whole agreement pointless. This is standard lawyer stuff.
(f) All rights and obligations hereunder will be governed by the laws of the State of [Governing Law Jurisdiction], without regard to the conflicts of law provisions of such jurisdiction.
What state in the US governs the SAFE? You normally enter input the state of your main office (e.g Delaware). This is a “choice of law” clause, not a “choice of jurisdiction”.
In reality, this means that you can be taken to court in any state, but the laws that apply are the state you are incorporated. Not where the court is held.
(g) The parties acknowledge and agree that for United States federal and state income tax purposes this Safe is, and at all times has been, intended to be characterized as stock, and more particularly as common stock for purposes of Sections 304, 305, 306, 354, 368, 1036 and 1202 of the Internal Revenue Code of 1986, as amended. Accordingly, the parties agree to treat this Safe consistent with the foregoing intent for all United States federal and state income tax purposes (including, without limitation, on their respective tax returns or other informational statements).
This is a tax section. It says it is an equity not debt instrument for the purposes of tax.
(Signature page follows)
IN WITNESS WHEREOF, the undersigned have caused this Safe to be duly executed and delivered.[COMPANY]
You and the SAFE MFN investor put in your details. Easy, duh.
Conclusion on the SAFE MFN
Hope you know what is in the document. If you are a lawyer and have something to add, let me know so I can update! I’m not a lawyer and this is not legal advice.
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