A founder's guide to SAFEs: fast-tracking investment for UK technology start-ups

Key takeaways

• SAFEs enable early-stage founders to raise capital quickly without needing to agree an upfront valuation, which minimises lengthy negotiations.
• Regulatory compliance is essential, founders must ensure their fundraising communications comply with UK financial promotions rules and that the company has proper corporate authority to issue shares on a future conversion.
• ASAs were developed as the UK equivalent of SAFEs, structured as equity pre-payments to preserve eligibility for SEIS and EIS tax reliefs.
• Speed matters: SAFEs and ASAs are increasingly vital for AI and tech start-ups needing to close funding rapidly and deploy capital immediately

SAFEs, ASAs and SEIS relief: navigating early-stage funding as a UK tech founder

The opportunities arising from the rapidly increasing demand for acquiring AI-powered platforms, machine learning applications, direct-to-consumer technology solutions and other deep-tech ventures are making early-stage start-up businesses evermore strategically appealing to domestic and international angel investors, venture capital firms and high net worth individuals. As the pace of innovation accelerates and the capital requirements of early-stage technology businesses continue to grow, founders and investors are seeking alternative routes to investment that balance their need for flexibility and efficiency with legally compliant and robust documentation.  

Enter the Simple Agreement for Future Equity, or SAFE. Introduced by the Silicon Valley start-up accelerator Y Combinator, the SAFE was designed to supercharge the ability of start-up businesses to raise early-stage capital quickly, cheaply and on founder-friendly terms. Before the SAFE, founders seeking pre-seed or seed investment were typically required to either negotiate a priced equity round, which demanded an agreed valuation and lengthy legal documentation, or issue convertible loan notes, which introduced unwanted debt onto the balance sheet and carried the burden of interest payments and maturity dates. The SAFE seeks to strip away a number of these complexities by offering an equity-like structure that incentivises investors to provide financial capital to early-stage businesses without the need to agree a valuation at the outset, without imposing any debt obligation on the company, and without accruing interest or imposing a fixed repayment timeline. Since its introduction, the SAFE has become the dominant fundraising instrument for pre-seed and seed-stage start-ups across the United States.

SAFEs versus traditional funding structures

For investors, the SAFE offers an accessible and cost-effective entry point into high-growth businesses at the earliest stage which rewards the investor for the additional risk assumed by investing before the company has a demonstrable track record. Typically a SAFE will provide for the investor to be issued shares upon a future equity funding round at a discount to the price paid by other investors as part of this round thus rewarding them for the higher risk of investing at an earlier stage.

For founders, a significant advantage of the SAFE mechanism is that it does not create a debt obligation, meaning the founder is not exposed to the risk of a repayment demand by the investor if the business does not achieve a subsequent funding round. Unlike convertible loan notes, there is no interest accruing on the investment and no maturity date looming over the business, allowing founders to focus their energy on growing the company rather than managing varying repayment dates and conversion mechanisms.

The negotiation process is also typically simpler with the parties needing to agree on only one or two key commercial terms, such as the valuation cap and / or discount rate, reducing both the legal costs and the time required to close a deal. A valuation cap sets a ceiling on the company valuation at which the SAFE will convert into equity, ensuring that early investors are rewarded if the company's value increases significantly before the next priced round. A discount rate entitles the SAFE investor to convert their investment into shares at a percentage discount to the price per share paid by investors in the next priced round, again rewarding the early investor for the additional risk when the company's prospects were less certain.  

The fine print: what founders need to get right

Founders should carefully consider the legal and commercial implications before agreeing to enter into a SAFE. In particular, because a SAFE ultimately relates to the acquisition of shares, any communication inviting or inducing a person to invest via a SAFE is likely to be caught by the UK's financial promotions regime. This means that the way in which a SAFE is marketed or offered to potential investors must comply with applicable rules, including ensuring that any promotional communication is made or approved by an appropriately authorised person or falls within a recognised exemption.

Founders should take legal advice at an early stage to ensure that their fundraising communications are compliant and to avoid the significant consequences, both civil and criminal, that can flow from a breach of the financial promotions rules.
Founders must also confirm that the company has the required corporate authority to issue the shares that will result from the conversion of the SAFE, including ensuring that the company's articles of association permit the allotment of the relevant class of shares, that any existing shareholder pre-emption rights have been disapplied, and that the board has the necessary authority to allot and issue the applicable shares.

Under UK legislation, directors of a private company with only one class of shares may allot shares without additional shareholder authority, provided the company's articles do not prohibit this. However, where the company has more than one class of shares, or where the articles restrict the allotment of new shares, the directors will require an express authority from the shareholders to allot shares in advance of entering into the SAFE. Founders also need to be aware of pre-emption rights which protect existing shareholders. Pre-emption rights entitle each existing shareholder to be offered a proportion of the new shares equal to their existing holding before any newly allotted shares can be offered to any third party. These rights exist to protect shareholders against involuntary dilution of their ownership. Founders should therefore review the company's articles carefully and, where necessary, pass the appropriate resolutions to disapply pre-emption rights in connection with the SAFE conversion, ensuring the company can issue shares to the SAFE investor without impediment.

Founders should also consider the impact of the SAFE on future investment rounds and, in particular, the impact it may have on future investors’ appetite for investment. Where they are investing and another party is receiving shares at a discount, that may impact the valuation they are willing to ascribe to the Company and the amount they are willing to agree to invest.

Preserving tax relief: making SAFEs work with SEIS and EIS

In the UK, the adoption of SAFEs has been notably slower than in the United States, in large part due to the significance of the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) tax reliefs. These schemes offer investors generous tax reliefs on qualifying investments, making them a powerful incentive for angel investors and a near pre-requisite for any early-stage fundraise in the UK market. However, SEIS and EIS relief is only available in respect of qualifying equity investments and is not available where funds are advanced by way of a loan or other debt instrument. The traditional US-style SAFE does not result in the immediate issuance of shares, and there has accordingly been a concern that it may not satisfy the requirements for SEIS or EIS relief. The UK market has responded to this challenge by developing the Advanced Subscription Agreement (ASA), which is functionally similar to a SAFE but structured as a genuine equity pre-payment rather than a convertible instrument. Under an ASA, the investor pays for shares in advance, with the shares to be issued at a later date, typically on the occurrence of the next qualifying funding round or a longstop date. If properly structured, an investment made under an ASA can qualify for SEIS or EIS relief, enabling UK investors to benefit from the tax advantages of these schemes whilst still providing fast, flexible capital to early-stage businesses. The interaction between SAFEs, ASAs, and the SEIS and EIS regimes is technically complex and fact-sensitive, and both founders and investors should obtain specialist tax advice at an early stage to ensure that any proposed instrument is structured in a manner that preserves eligibility for the relevant reliefs.

A catalyst for AI and technology businesses

In this fast-paced environment, where the competitive advantage of being a disrupter can be decisive and the window of opportunity to secure market position may be measured in months rather than years, the ability to raise capital quickly and without the friction of a full priced and negotiated round is of critical importance. SAFEs and their UK equivalent, the ASA, are ideally suited to this landscape. They allow founders to close funding in a matter of days, receive capital immediately and deploy it towards building the business, while deferring the valuation discussion to a point at which the business has sufficient performance data and further third-party evaluation to justify a fair price. For investors, the structure provides early access to potentially transformative businesses at a preferential entry point, with the knowledge that their capital is being deployed directly into growth and development. As the technology sector continues to attract significant investor interest and as the capital requirements of AI businesses continue to grow, we expect that the SAFE and the ASA will increasingly become important tools for founders and investors seeking to move at the speed that innovation demands.