The SAFE (simple agreement for future equity) is the standard instrument for early rounds. It is simple to sign. It is less simple to account for, and its dilution is easy to underestimate when several SAFEs stack up before a priced round.
How a post-money SAFE converts
A post-money SAFE with a valuation cap gives the investor ownership equal to:
Investment ÷ post-money valuation cap
measured against the company's capitalization just before the priced round's new money, including all SAFEs and the option pool as defined in the SAFE.
A worked example
Before the priced round, founders and the pool hold 9,000,000 shares. The company raised:
| SAFE | Investment | Post-money cap | Ownership at conversion |
|---|---|---|---|
| A | $500,000 | $10,000,000 | 5.0% |
| B | $1,000,000 | $12,500,000 | 8.0% |
| Total | $1,500,000 | 13.0% |
Founders and the pool are diluted to 87.0% before any Series A money. If the Series A then sells 20% of the post-money company, everyone above, SAFE holders included, is diluted by that 20%:
| Holder | Before Series A | After Series A |
|---|---|---|
| Founders and pool | 87.0% | 69.6% |
| SAFE holders | 13.0% | 10.4% |
| Series A investors | 20.0% |
Run this table before signing each new SAFE, not after the term sheet arrives. Many term sheets also ask for the option pool to be expanded before the round, which further dilutes existing holders.
Balance sheet classification
Under ASC 480, an instrument that can require the issuer to transfer cash or assets upon events outside the issuer's control is often classified as a liability. Standard SAFEs can require a cash payment in a liquidity or dissolution event, so many companies classify them as liabilities, measured at fair value with changes reported in earnings, until conversion. Some SAFEs, depending on their terms, qualify for equity classification. The conclusion should be documented in a short accounting memo per instrument.
At conversion, the SAFE balance moves to preferred stock and additional paid-in capital.
Tax treatment
The federal tax treatment of SAFEs is not settled by specific guidance. Most practitioners treat standard SAFEs as equity-like (not debt) for tax, meaning no interest deductions and no income to the company when cash is received. Document the position.
Securities filings
SAFEs are securities. Most are sold under Regulation D, which requires a Form D filed with the SEC within 15 days after the first sale, plus state notice filings where required.
Records to keep
- Signed SAFEs with cap, discount and post-money or pre-money terms
- Wire confirmations matching each investment
- Board approval
- Form D and state filings
- The conversion model, updated after each new SAFE
We record SAFEs correctly from the first one, maintain the conversion model alongside the cap table, and book the conversion entries when the priced round closes.
Sources
- FASB Accounting Standards Codification, Topic 480, Distinguishing Liabilities from Equity
- Y Combinator, SAFE financing documents
- SEC, Filing a Form D notice
- Investor.gov, Form D
Questions founders ask
Are SAFEs debt?
Not in the legal sense; they carry no interest or maturity. For GAAP, many SAFEs are classified as liabilities because certain events can require the company to pay cash, which is a separate question from whether they are debt.
Do post-money SAFEs dilute each other?
No. Each post-money SAFE holder's ownership is fixed relative to the company capitalization at the cap, so additional SAFEs dilute the founders and other existing holders, not earlier SAFE holders.
