Q&A on the Post-Money SAFE under Swiss law

Alain Friedrich
Alain Friedrich

One of the great advantages of Y-Combinator's Simple Agreement for Future Equity (SAFE), which is structured as a convertible loan in Switzerland, is its standardisation and simplicity. The following article is intended to explain the post-money SAFE and to demonstrate its advantages.

1. What is a Post-Money SAFE?

The term SAFE is an acronym for Simple Agreement for Future Equity. Under Swiss law, the SAFE is usually structured as a non-interest-bearing convertible loan (debt) with a subordination agreement.

In a SAFE, an investor grants an early-stage start-up an interest-free loan that is later converted into equity. The investor generally has no repayment claim. Rather, he undertakes to convert his SAFE into shares at the first capital increase after conclusion of the SAFE (“Equity Financing”).  

The terms of the conversion are standardised. Usually, only the post-money valuation cap is negotiated.

The term post-money valuation differs from the more familiar term pre-money valuation only in that the pre-money valuation refers to the valuation of the company immediately before an investment and post-money valuation refers to the valuation of the company immediately after the investment. For example, if a company does a CHF 2 million financing round with a pre-money valuation of CHF 10 million, this means nothing more than that the company raises CHF 2 million with a post-money valuation of CHF 12 million.

The post-money valuation cap is the maximum company valuation after conversion of all outstanding SAFE investments (but before the capital increase [Equity Financing] triggering the conversion).

At the conclusion of a SAFE, investors therefore know what company stake they will receive after converting SAFE (e.g., 10% for an investment of one million), i.e., there is no dilution by other SAFE investors.

However, all SAFE investors are diluted by investors participating in the first capital increase, which gives rise to the conversion of the SAFE. Therefore, some companies give their SAFE investors the opportunity to participate in the financing round by providing them so-called pro-rata rights. By doing this, SAFE investors (who invest further capital) are not diluted and maintain their initial stake.

Here is a simplified example for the mechanics of a post-money SAFE:

Immediately after its foundation, XYZ AG has a share capital of CHF 100,000.00, divided into 1,000,000 registered shares with a nominal value of CHF 0.10 each. The ordinary shares are held by founder X and founder Y with a participation of 50% each. XYZ AG raises a total of CHF 1 million from two investors after its formation.

Investor A signs a SAFE with a loan amount of CHF 200,000.00 and a post-money valuation cap of CHF 4 million. Investor B signs a SAFE with a loan amount of CHF 800,000.00 and a post-money valuation cap of CHF 8 million.

After signing the two SAFEs, the company knows that 15% of the company will go to the SAFE investors:

Investor A = 200k / 4m = 5%.

Investor B = 800k / 8 Mio. = 10%

18 months after signing the SAFE, XYZ AG signs a term sheet according to which the company conducts out a financing round at a pre-money valuation of CHF 15 million and raises a total of CHF 5 million from an institutional investor Z.

How does the shareholding structure look like at the different stages?

Shareholding structure before the conversion of the SAFE:

Ein Bild, das Tisch enthält.Automatisch generierte Beschreibung

Shareholding structure just after the conversion of the SAFE:

Ein Bild, das Tisch enthält. Automatisch generierte Beschreibung

Shareholding structure after the conversion of SAFE and the financing round:

Ein Bild, das Text, Quittung, Screenshot enthält.Automatisch generierte Beschreibung

2. What other points should be kept in mind?

How are options (issued or promised) treated?

To calculate the share of the company to which the SAFE investor is entitled to, not only outstanding shares immediately prior to the financing round but also options (issued or promised) are to be considered (as well as conditional and authorised capital).  

On the other hand, shares newly created during the financing round are not considered for the conversion of the SAFE and will dilute all SAFE investors.

What is the purpose of the "Most Favoured Nation" clause?

Thanks to the design of the SAFE, a company may agree on different post-money valuation caps with different investors. This gives the company the greatest possible freedom.

However, if a company includes a so-called Most Favoured Nation (MFN) clause in the SAFE, investors may ask the company to adjust the initial terms to the terms of a newly signed SAFE with more investor-friendly terms.

When is the SAFE converted into equity?

The conversion of an outstanding SAFE is mandatory at the first equity financing round following the conclusion of the SAFE. There is no specific funding threshold and SAFE investors are required to convert the loan into shares at that equity financing round.

What happens if the company is sold before the SAFE is converted?

If the company is sold or listed on a stock exchange before the SAFE has been converted, the investor is entitled to receive the higher of the following amounts: (i) repayment of the initial loan amount, or (ii) entitlement to the portion of the sale proceeds to which the SAFE investor would have been entitled to, had the conversion taken place before the sale or listing and at the post-money valuation cap.

What happens if the Company ceases trading?

If a company ceases to operate, the SAFE investor is generally entitled to recover the initial loan amount unless the loan may not or not fully be repaid, e.g., due to the agreed subordination.

Can a SAFE be terminated? 

In principle, the SAFE cannot be terminated and only ends in the event of an equity financing, a liquidity or a dissolution event. Termination for cause is however always possible.  

What type of shares will SAFE investors receive upon conversion?

In the event of a conversion, SAFE investors generally receive the same preferred shares as investors who subscribe to shares during the financing round. As a rule, only the issue amount and the liquidation preference differ.  

Why do we recommend a subordination?

Under Swiss law, a SAFE is structured as a loan and for early-stage start-ups, there is a risk of over-indebtedness according to Art. 725 CO.

Accordingly, any company raising capital through a SAFE is recommended to include a subordination agreement in accordance with the requirements of Art. 725 para. 2 CO.

Who must approve the conclusion of a SAFE?

The conversion of a loan into equity is usually done by the general meeting of shareholders. Accordingly, the SAFE should either be signed by the existing shareholders, or a separate agreement must be concluded between the shareholders in which they consent to the conversion.  

3. Why is the SAFE so popular?

With a SAFE, a company may raise capital without much administrative or negotiating efforts. Furthermore, there is little coordination effort required, as SAFEs can generally be concluded at any time and independently of each other. Furthermore, a SAFE can be supplemented with additional arrangements as desired. An option that is regularly used in practice.  Finally, a post-money SAFE is also interesting for investors because they know immediately after the conclusion of the agreement which share of the company they are acquiring. Something that is different if you use pre-money valuation as a valuation basis.   

Disclaimer: The information contained in this article is for general information purposes and does not constitute legal or tax advice. In specific individual cases, the present content cannot replace individual advice by expert persons.

 

 
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