Reed Smith In-depth

The simple agreement for future equity (SAFE) instrument has become a popular tool for making early-stage financings in the United States (arguably, more popular than convertible bonds), but the uptake of similar instruments in Hong Kong has been relatively slow. In essence, a SAFE instrument involves making an up-front investment, with a future conversion into equity at a valuation to be determined at that time based upon the occurrence of a future funding round, which can incorporate an optional conversion cap and/or conversion discount. Unlike a convertible bond, it is not a debt prior to conversion and it has no maturity date.

The traditional SAFE instrument does not contain key investor protections typically found in a convertible bond. However, a SAFE instrument is cheap and easy to use and is well understood by the U.S. venture capital investment community, where the YCombinator SAFE instrument is now widely used, but it is not well understood in Hong Kong.

With the increasing attention paid to start-ups (particularly ‘unicorns’) in the Asia-Pacific region, a SAFE-like instrument can be a useful addition to the early-stage investor’s toolbox, especially where the start-up investee is very difficult to value, or where bridge financings which are small relative to the proposed next round financing are contemplated.

Authors: Mark Nicholas Cornell Letty Luk Keith Tse

Introduction

In the United States, the earliest stages of financing a company are usually done with convertible instruments such as a convertible bond or simple agreement for future equity (SAFE), with fixed price equity issues1 occurring on a less frequent basis.  

AngelList (a platform for start-ups which, among other things, compiles data regarding angel investments in the United States) tracked individual investments made through its network which (a) utilised convertible instruments (including SAFE instruments) with a valuation cap under US$20 million, and (b) were made before any fixed price equity financing round (which serves to isolate ‘bridge rounds’ between fixed price equity financing rounds), and the following results illustrate an increasing use of SAFE instruments since their introduction in 2013:

SAFE instruments for Hong Kong venture capital investing table

Source: Abe Othman’s article titled “For Seed Funding, SAFEs Have Won Against Convertible Notes” dated 21 August 2019 published on the AngelList Blog