When it comes to investing in early-stage startups, there are always higher risks involved. This is where the concept of a discount in a SAFE (Simple Agreement for Future Equity) comes into play. The discount is essentially a benefit for the SAFE investors to compensate for the added risk they take on compared to later-stage investors.
So, how does this discount on a SAFE work? Well, let me break it down for you.
1. Understanding the SAFE: First, let’s quickly understand what a SAFE is. It is a type of financial instrument that startups use to raise capital. Instead of issuing shares, the startup promises to grant the investor equity in the future, typically upon a future financing round or event.
2. Discount as a Risk Mitigation: Early-stage startups often face more uncertainties and risks compared to more established companies. Therefore, as an investor, it is reasonable to expect some form of compensation for taking on these higher risks. This is where the discount comes in.
3. Discount Off the Price per Share: The discount in a SAFE is a reduction off the price per share paid by new investors in an equity financing round. Let’s say a startup raises a subsequent round of financing at a certain valuation. The discount would apply to the price per share that the SAFE investor would receive when converting their investment into equity.
4. Range of Discounts: The discount percentage can vary depending on the negotiation between the startup and the investor. It typically ranges from 5% to 30%, with 20% being the most common. This means that the SAFE investor would receive shares at a discounted price compared to the new investors in the subsequent financing round.
5. Example Scenario: Let’s say a startup raises a Series A financing round at a valuation of $10 million. If a SAFE investor had a 20% discount, it means they would convert their investment into equity at a price per share that is 20% lower than the price per share paid by the new investors in the Series A round.
6. Benefits for the SAFE Investor: The discount allows the SAFE investor to acquire more shares for their investment compared to the new investors in the subsequent round. This can potentially lead to higher returns if the startup succeeds and its valuation increases over time.
7. Balancing Founder and Investor Interests: The discount is a crucial element in aligning the interests of the startup founders and the early-stage investors. It incentivizes investors to provide capital to startups in their early stages, while founders can secure funding at a lower valuation.
8. Negotiated Terms: The specific terms of the discount, including the percentage and any associated conditions, are typically negotiated between the startup and the SAFE investor. It is important for both parties to reach an agreement that is fair and reasonable given the circumstances.
The discount in a SAFE is a mechanism to address the higher risk of investment that SAFE investors take when investing in an early-stage startup. It provides them with a discount off the price per share paid by new investors in the subsequent equity financing round. This discount helps balance the interests of both the startup founders and the early-stage investors, while also potentially offering higher returns for the investors if the startup succeeds.