For early-stage investments, the valuation of a startup is strongly influenced by subjective factors, such as how the investors view the business, market conditions and management team of the startup. While there are no objective benchmarks, such valuations are especially vulnerable to an uncertain economy. The future impact of current wars and geopolitical crises on our economy makes it difficult for both investors and startups to assess the valuation of early-stage companies.

Valuation is very important for startups. If the valuation of a company is too high, there may likely be a down-round in the next equity financing. If the valuation is too low, the company may give away too much of its ownership for the amount of capital raised. What can a startup do to obtain funds and reduce the risk of a next down-round equity financing during volatile market circumstances? Founders may consider using Simple Agreement for Future Equity (“SAFE”) to reduce the risk of valuation due to uncertainty in market.

The SAFE structure was created by Y-Combinator for startups to raise money at an early stage. SAFEs provide a means to raise money without setting a fixed valuation. The SAFE has many merits, but investors and founders need to fully understand the SAFE structure and its potential shortfalls.

As mentioned above, SAFEs are a good strategy to avoid setting the current valuation of the company to avoid a down-round. The startups and the investors only fix a valuation cap in the SAFE instrument and agree that the valuation will be determined in a subsequent equity round. SAFEs are usually standard agreements. The standardized format and simplicity help startups save legal fees and negotiation time in raising funds. SAFEs are easy to understand which help startups attract smaller investors who are ready to invest. Compared to convertible notes, SAFEs have no interest rates and no maturity dates. This saves startups money on interest and reduces the time pressure to raise an equity round.

However, SAFEs usually raise relatively smaller amounts of capital than a formal equity round. Founders of startups need to realize that using multiple SAFE rounds can result in a very complex cap table and may cause unexpected significant dilutions to the ownership of the company. SAFEs attract smaller, non-institutional investors who may not be able to provide expert business guidance.

Conclusion

SAFEs may provide a simple, quick and easy way to raise money when the economy is uncertain that allow startups and investors to focus on financing of the company without the risks associated with setting a valuation that is too high or too low in a volatile market.

At Coepio Legal, we’re here to help you navigate the complex world of VC financing. Whether you’re a founder of a startup or an investor, reach out to us today for professional guidance and support.

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1″Down round” equity financing means the company values less than the previous round of equity financing, i.e. the price of the shares of the company in the current financing is lower than the price of the shares sold previously.

 2“Valuation cap” means a ceiling, or cap, on the pre-money valuation at which the SAFEs will convert in the next equity financing. If the startup’s valuation in the next financing is greater than the valuation cap, the SAFE investor’s money will convert at the valuation cap.