The New Post-Money SAFE and SAFE-like Contracts Used in Turkish Startup Ecosystem
SAFE (Simple Agreement for Future Equity) minimizes complexity, legal fees, tax consequences and disputes, and yet it is disliked by many investors. Investors do not feel on the “safe” side when signing a SAFE considering it is merely a promise to issue equity to the SAFE holder in case of an equity-financing round. It is not a debt instrument so it does not have any maturity date or interest rate. As neither a creditor nor an equity holder, investors are sometimes reluctant to invest in a startup using SAFE document, however it is still a popular way of investing in an early stage startup in the Silicon Valley. Experienced Silicon Valley investors know that one of the most crucial advantages for an early stage startup in highly competitive markets is the first mover advantage. So raising funds for product development fast and cheap will eventually benefit not only the Company but also the investors. In any case, no matter you use 5 pages SAFE or 50 pages stock purchase agreement for investing in a early stage startup, it is a big risk that only sophisticated investors should take.
While the startup ecosystem in Silicon Valley is evolving, legal instruments continue to evolve too. Towards the end of 2018, Y Combinator has introduced a new SAFE making few changes on the previous one that has been widely used by early-stage startups since 2013. According to YC, SAFE needed certain changes due to the new dynamics of the start-up ecosystem such as higher amounts of investment money and needing more independent financing rounds. These changes have the potential to serve the interests of both investors and startups.
The new SAFE is called the “post-money SAFE” as the major change on the previous SAFE is that the ownership of investors will no longer be measured with pre-money cap. This simply means the amount of money negotiated between investors and companies will not be affected by the other SAFEs executed as all the SAFE money will be accounted for when calculating the ownership of investor. You may say that the investor can simply adjust itself according to the percentage it wants to hold, but this is highly important especially when there are several SAFE rounds involved. More SAFE rounds create complexity in calculations as well as making it hard to predict the ownership percentage for both investors and the founders. Post-money valuation assures more certainty and transparency for both sides as well as making calculations much faster with less help from accountants and lawyers.
Furthermore, the first SAFE introduced by Y Combinator allowed every SAFE holder investor to have pro rata right which lets them to purchase a pro rata portion of the preferred stock of the next series. Pro rata right can be simply explained in short as a preference to be able to participate in a subsequent round to keep investor’s ownership percentage. Institutional investors in subsequent rounds might not want early investors to participate in order to get more equity of a promising startup. As pro rata right usually becomes a treasure to fight for granting it to each and every early investor did not serve well especially for startups. Instead, YC drafted a new optional template side letter to be entered into depending on the considerations such as the purchase amount of the SAFE and the amount of possible future dilution for the founders.
Some other changes on the previous SAFE can be considered as minor but they surely support the main reasons the SAFE was invented for: to be simple and act as a separate financing tool. One of such changes is that SAFE is no longer a bridge into a later round but separate financing since the new SAFE includes right to receive dividends and right to receive the same compensation choices in a liquidity event as equity holders. Another change is the part at the beginning of the document stating “This Safe is one of the forms available at http://ycombinator.com/documents and the Company and the Investor agree that neither one has modified the form, except to fill in blanks and bracketed terms.” While this surely cannot remove the principle of freedom of contracts, and the parties can still amend it, it is a great reminder that there is no need to amend it. Often, lawyers like to charge for small changes that were never needed in the first place, or they might not even understand the dynamics of the document so it takes months to review it especially when the lawyers are not familiar with such documents.
The necessity of such document in accelerating early stage investment processes is noticed in many other countries including Turkey. A few big law firms in Turkey has worked on preparing contracts that resemble SAFE in some ways, however it has not been able to go any further than translating certain provisions while hoping that it accords itself with the local commercial code. In our experience, with few exceptions, most documents drafted in Turkey to replace SAFE were either a debt instrument or a letter of promise with pages of harsh provisions protecting the investor. What is the purpose of using SAFE as an investment tool if you would like to define and cover every possibility that an entrepreneur would act in bad faith? Honestly, I do not believe that defining tens of pages of board reserved matters or general assembly reserved matters in a contract would protect the investors against people who would go to extreme lengths like graduating from top engineering schools, developing a software, working on it for thousands of hours and convincing few people to invest after pitching to hundreds.
Such approach in drafting SAFE-like documents is simply due to the cultural differences being reflected on the local startup ecosystem. While the entire system in the U.S. is built on the principle of trust, Turkish legal system’s foundation is distrust. Hence the hundreds of pages of contracts that aim to limit entrepreneur’s discretion and hold him/her accountable of any misdeed even in the case of few thousand dollars investments. Thankfully, Turkish startup ecosystem adapts very fast to the expectations of the global needs. We now see many noteworthy efforts in Turkish startup law as many important actors have started realizing the importance of such investment tools in promoting the healthy growth of the ecosystem.
Dr. Aylin Sahin, CEO, Igniters Tech Consulting
(Disclaimer: Nothing in this article constitutes legal advice, please consult with a licensed attorney in your jurisdiction)