How Do SAFEs Work and Get Converted?

Fundraising for a start-up is quite challenging. You have a business that requires financing to grow, but giving up equity in the company is not something you wish to do at this early stage. That’s where SAFEs or Simple Agreements for Future Equity come into the picture. Now, here’s the question: how do SAFEs work and get converted? 

Compared to the traditional funding models, such as equity-priced rounds, SAFEs are more manageable and faster to close. That’s the reason they have gained tremendous popularity among early-stage start-ups and angel investors. In this guide, we will explain how SAFEs operate, how they are converted, and what you should consider when fundraising with SAFEs. Let’s dive in!

How Does a SAFE Work?

SAFE stands for simple agreement for future equity. It is an agreement between the investor and the startup. While raising money through SAFE, there is a transfer of funds from the investor to the company. In return, they receive future equity each time the company gets more funds or goes through an acquisition. 

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Benefits: No interest payments, no scheduled repayments, and no upfront fixed valuation, making it especially founder-friendly and popular in Silicon Valley and among Y Combinator alums.​

How It Works: Investors give startups cash; in return, they get a convertible right to future equity if/when a “conversion event” occurs (such as a fundraising round, acquisition, or IPO).

How do SAFEs help a startup? Well, unlike a conventional loan, they do not charge interest or require the borrower to pay back the amount borrowed. Moreover, unlike a priced equity round, you don’t start with a set valuation. These reasons make SAFEs cheap, versatile, and favourable to the founders when fundraising. 

For entrepreneurs, SAFEs are an option that, in most cases, allows them to avoid negotiations with investors. Nevertheless, the absence of immediate valuation of the note makes it challenging to determine its value within the company until a conversion event happens.

Discounts and Valuation Caps

SAFEs contain features such as discounts and valuation caps. Here’s what they mean:

Discount: This enables SAFE investors to purchase shares at a better price than later investors. For example, if a SAFE has a 20% discount and the next funding round values shares at $1, then the SAFE investor buys them for $0.80. Discounts help to compensate for the additional risk of investing in the startup before it generates more evidence of success and its commitment. Suppose a startup achieves product-market fit before receiving a priced round. In that case, SAFE investors with a discount will have a lower cost basis, which would give them the greatest possible return on investment.

Valuation Cap: This sets a cap on the price at which the SAFE converts into shares. If a SAFE has a $5M cap and the following round values the company at $10M, then the SAFE investor is much better off when converting his investment to equity. Valuation caps are set to ensure that early investors receive a certain percentage of the equity before conversion, even though the company has a higher value at conversion. It also provides fairness between the founder and the investor regarding equity sharing.

These features lock in early investors and provide them with incentives through a high risk-to-reward ratio. A lack of specific information on the valuation cap may lead investors to receive a smaller percentage of the company if the business's value soars at the time of SAFE conversion. It also helps startups attract investors while keeping more funding options open.

Main SAFE Conversion Events - What Triggers Equity

SAFEs convert into shares or other benefits when specific milestones (“conversion events”) happen:

Priced Equity Round: When a startup raises capital in a conventional round, SAFEs are converted into stock. This type of conversion is the most common associated with growth to a certain level, enabling the company to set a share price and attract institutional shareholders.

Acquisition or IPO: If the company is acquired or goes public before a priced round, SAFE investors may receive cash or stock, as per the terms of the SAFE. This outlook is positive for investors if the acquisition or IPO occurs at a high valuation. Still, if the firm exits at a lower valuation, SAFE investors may receive less than they expected.

Liquidation: If the company ceases operations before a conversion event occurs, SAFE investors are treated similarly to equity shareholders, with no ownership claims to the company. Nevertheless, sure SAFEs do have dissolution rights, which state that investors are repaid in part, especially when there are any remaining balances before shutting down.

Knowledge of conversion events is essential for both founders and investors. They define the circumstances and dynamics under which SAFE investments are converted to equity and the subsequent impact on ownership and financials. All these possibilities should be explained to investors before venturing into the business, so that appropriate expectations are set from the outset.

Advanced SAFE Terms and Clauses

Most Favored Nation (MFN) Clause:
The Most Favored Nation (MFN) clause is a powerful protective provision commonly found in some SAFEs and convertible notes. Its primary purpose is to ensure that early investors aren’t disadvantaged if future investors receive better terms. If a startup issues a later SAFE with more favorable conditions (such as a lower valuation cap or higher discount), existing SAFE holders with an MFN clause have the right to “amend up” their terms to match those more investor-friendly terms. This clause can reassure early-stage investors that they won’t miss out on improved deals down the line, creating trust and encouraging faster, earlier funding. 

• Example: Suppose Investor A invests with an MFN clause in their SAFE, agreeing to a $2M valuation cap and no discount. Three months later, Investor B invests under a $1.5M valuation cap or with a 10% discount. Thanks to the MFN, Investor A can revise their agreement to the more favorable $1.5M cap or add the discount, thus ensuring a level playing field.
  
• MFN clauses generally apply only once—the first time better terms are offered after the original agreement.
  
  

Pro-Rata Rights:

‍ Pro-rata rights are a provision that allows investors to maintain their ownership percentage if the startup raises additional funding in subsequent rounds. This means, as new shares are issued and more capital is raised, existing SAFE holders can invest further (“pro-rata up”) to avoid dilution and keep their shareholder percentage steady.

• Example: If an investor owns 3% post-SAFE conversion, pro-rata rights allow that investor to buy enough additional shares in the next round to maintain a 3% ownership, even as new capital comes in.
  
• This is especially attractive to early-stage investors if the company grows quickly and its valuation rises in later rounds, since it preserves their influence and potential upside.

Pre-Money and Post-Money SAFEs

SAFEs exist in two forms: pre-money and post-money.

Pre-money SAFEs: The initial form of this financing instrument. The conversion occurs at the pre-funding valuation after the investors contribute new funds. The term was unclear regarding the percentage of company ownership SAFE investors would attain. The valuation set before new investments made it hard for investors to assess ownership shares in pre-money SAFEs accurately. The founders faced difficulties due to SAFE dilution, which occasionally led to unforeseen equity-allocation issues.

Summary: Original SAFE model; conversion terms are based on the company value before the next round’s investment arrives.

‍Post-money SAFEs: The updated version of SAFEs. The post-money SAFE calculates investor equity by determining the number of shares after converting all SAFEs into equity. They provide precise ownership predictions to investors and founders, which helps them plan their funding strategies. Post-money SAFEs give greater clarity on equity distribution, making them a popular choice for both investors and startups.

Summary: Modern version; investor equity calculated after all SAFE agreements convert, providing transparent ownership stakes to both parties.

A startup should decide between a pre-money and a post-money SAFE based on its future investment approach and expectations of potential investors. Modern fundraising operations are increasingly shifting towards post-money SAFEs because these instruments offer both ease of use and precise documentation.

Pros and Cons of Using SAFEs

Pros:

Fast and Simple: No lengthy negotiations. Just sign and go. This made SAFEs a perfect fit for early-stage startups.

Founder-Friendly: There is no rush to set a valuation too quickly. Founders retain the freedom to decide the startup's valuation at some point in the future.

Investor Incentives: Discounts and valuation caps are offered to the investors. This allows investment in the early stages, when startups require capital most.

Cons:

• Uncertain Ownership: Some founders are unaware of how much equity they are putting into the business. It can create issues in the next rounds of funding.
• Investor Risks: There is a risk that a startup company will never complete a priced round of funding, meaning the SAFEs will never convert.
• Potential Dilution: Excessive use of SAFEs complicates a company’s funding rounds later on. Founders should always ensure their cap table does not dilute out of control.
  

Step-by-Step Guide to Fundraising with SAFEs

Fundraising with a SAFE is quite simple:

Set Terms: Agree on your valuation cap, the discount, and any other set terms. Consider market factors and investors' expectations.

Find Investors: Go to angel investors, venture capitalists, or friends with deep pockets. Introduce your startup and present the rationale for investing through SAFE.

Follow a Standard SAFE Template: Y Combinator provides a common SAFE agreement. It also ensures compliance with the industry-standard.

Sign and Collect Funds: Once investors agree to invest, they sign the SAFE and transfer the money. Always keep these agreements documented.

Track Your SAFEs: Know who invested and the terms for that investment. Documenting is very important for fundraising. 

Convert When Ready: When a conversion event occurs, SAFEs are converted to equity. Avoid risks and potential pitfalls by planning.

Deep Dive: Scenario-Based Conversion Example

Suppose your startup issues a $50,000 SAFE with a $5 million valuation cap and a 20% discount. The next round is priced at a $10 million valuation:

• Using the valuation cap, the SAFE converts as if the valuation is $5M, resulting in more shares for the investor versus a straight discount calculation.​
• Example calculation:
  
  • Discounted share price: $5 * (1 – 20% discount) = €4
  • Shares received via discount: $50,000 / $4 = 12,500
  • Shares received via cap: $5 * ($5M cap / $10M valuation) = $2.50; €50,000 / $2.50 = 20,000
• The investor will select the conversion scenario that yields the highest share count.

Latest Trends: SAFE Agreements in 2025

• SAFEs remain the dominant instrument for early-stage startup fundraising, now widely used by both angels and venture capitalists.​
• Recent legal updates clarify that SAFEs are considered equity transactions—not debt—if they meet certain jurisdictional conditions (especially relevant for tax treatment in high-tech sectors such as Israel).​
• More startups are using post-money SAFEs, which lock in fixed investor ownership and increase transparency for both founders and investors.​

Takeaways and Action Steps

• SAFEs are ideal for safeguarding founder equity and rewarding early investors—when executed carefully with clear caps, discounts, and standard documentation.
• Avoid cap table chaos by tracking each SAFE, prioritizing post-money versions, and seeking legal counsel for conversion events.
  

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FAQs

What is a SAFE agreement?

A SAFE (Simple Agreement for Future Equity) is a funding contract where investors provide early-stage capital in exchange for future equity in the startup, usually converting during a priced funding round or liquidity event. Unlike debt, SAFEs have no interest or maturity date.

How does a SAFE convert into equity?

SAFEs convert during “conversion events” such as a priced equity round, acquisition, IPO, or liquidation. At conversion, investors receive shares based on agreed discounts or valuation caps.

What are valuation caps and discounts?

A valuation cap sets the maximum company valuation at which a SAFE converts, protecting early investors from excessive dilution. Discounts allow investors to buy shares at a reduced price compared to later funding rounds.

What is the difference between pre-money and post-money SAFEs?

Pre-money SAFEs calculate ownership before new investments, which can lead to unclear dilution. Post-money SAFEs calculate ownership after all SAFEs convert, offering greater clarity on investor equity.

What risks do investors face with SAFEs?

If a startup never reaches a conversion event, SAFEs might never convert, and investors may lose their principal. Additionally, ownership percentages can be diluted if many SAFEs are issued.

Do SAFE investors have voting rights before conversion?

No. SAFE investors do not hold equity or voting rights until their investment converts into shares during a conversion event.

Can a SAFE be repaid in cash instead of equity?

Typically, SAFEs convert to equity, but some include provisions for repayment in cash or multiples of the invested amount if an acquisition or liquidity event occurs before conversion.

Conclusion

SAFEs is a well-known method for startups to get early-stage financing. SAFEs have been around for several years. They’re fast, flexible, and investor-friendly. However, with these comes strings attached, like the issue of ownership and dilution of shares at conversion. Making the complexities of SAFEs and their conversion understandable is necessary to assist both sides of the deal. 

We hope now you have got the answer to the aforementioned question - how do SAFEs work and get converted. If you want to learn more about investment and financing of startups, join the Venture Fundamentals course by Angel School. It is a great guide to learning the various aspects of financing startups. Happy fundraising!