Fund Your Startup With A Simple Agreement For Future Pizza
(Note: This post originally appeared on LinkedIn before I started writing on Medium.)
You’re bar-hopping on the town with a couple of your friends, and sooner or later you get tasked with pizza acquisition. The pizza is $8, but you only have $6. So you collect $1 from each of your friends Paul and Marissa; you promise them a slice each. If you didn’t collect some money before, you wouldn’t have enough money to pay the hole-in-the-wall pizza joint, and you wouldn’t be able to deliver your friends the pizza they were promised.
By collecting $1 in advance, you have basically entered into a Simple Agreement for Future Pizza with Paul and Marissa. You take their money, and if everything goes well and the pizza arrives, they each get a slice.
But the world is uncertain, fraught with pizza-denying risks. A demented French bulldog might snatch your cash and disappear down an alley. The pizza joint could be closed, so you might make a last-minute pivot and come back with burritos instead. Your friends will understand, they know it’s a risky venture: pizza.
With Paul and Marissa’s support, all is well, and you achieve pizza. A new friend, Mark, asks for a slice after the pizza arrives. You could charge him $2 a slice (double valuation!) because you and your early pizza investors had to take the upfront risk of the pizza not showing up.
The good folks at YCombinator created the Simple Agreement for Future Equity (SAFE), which is very much like getting pizza with friends. Selling a SAFE to investors is like selling them a slice of your company before it is built. Standard SAFE templates include clauses like:
- Valuation Cap: If your pizza pre-sale is $1 per slice and a pizza has 8 slices, it means you are “capping” or limiting the valuation of the whole pizza to $8.
- Pro rata rights: Friends who pre-ordered pizza get first dibs on extra slices when you sell them at $2 later. If Mark and Marissa both want the last slice of pizza, Marissa gets first dibs.
- Discount: Friends who pre-ordered pizza could get a discount on the $2 slices.
- MFN (Most favored nations): You have to be fair to all the investors during the pre-sale. You can’t charge Paul $2 per slice if you’re charging Marissa only $1 per slice.
There are a few major advantages in using SAFEs.
- Simplicity. It’s easy as pizza for noobs like me to understand.
- Negotiating speed. All you have to negotiate is the cost of a slice.
- Security. You don’t have to be worried about legal gotchas. Some of the smartest investors and lawyers in the world wrote the original SAFE templates, and hundreds of startups have used SAFEs successfully for their seed financing.
- Intent. Everyone wants pizza, so everyone is incentivized to help achieve pizza. You don’t want to be bickering about how fast the pizza will arrive or have Paul ask for his $1 back while you’re standing in line for pickup, etc.