SAF (Simple Agreement for Future Equity)

A SAF, or Simple Agreement for Future Equity, is a financing contract used by early-stage startups to raise capital. Pioneered by the famous startup accelerator Y Combinator in 2013, it offers a streamlined alternative to traditional fundraising methods. Think of it not as buying a piece of the company today, but as buying a ticket that guarantees you a piece of the company in the future. An investor provides cash to a startup in exchange for the right to receive company stock at a later date, typically when the company holds its first major priced funding round (like a Series A). Unlike a loan, a SAF is not debt; it doesn't accrue interest and has no maturity date. It's also not yet equity; the investor doesn't own shares or have voting rights until the agreement “converts.” It's a unique instrument designed for speed and simplicity, allowing startups to secure funding quickly without getting bogged down in complex negotiations about their current worth.

The magic of a SAF lies in its conversion mechanism. The investor's cash converts into equity during a future “triggering event,” which is almost always a priced equity financing round. To reward the early-stage investor for taking a significant risk, the SAF includes terms that give them a better deal than the later-stage investors. The two most important terms are the valuation cap and the discount rate.

The valuation cap is the most critical feature for an early SAF investor. It sets a maximum company valuation at which the investor's money converts into equity. This protects the investor from their stake being overly diluted if the company's valuation skyrockets in the next funding round. Example: Imagine you invest $50,000 via a SAF with a $5 million valuation cap. A year later, the startup is a runaway success and raises its Series A round at a $20 million valuation. The new investors are buying stock based on that $20 million price. However, because of your valuation cap, your $50,000 converts into stock as if the company were only worth $5 million. This means you get 4x more shares for your money than the Series A investors, a handsome reward for your early faith and risk.

A discount rate is another way to reward early investors. It gives them a percentage discount on the share price paid by investors in the future funding round. Discounts typically range from 10% to 25%. Example: You invest via a SAF with a 20% discount. The company later raises a Series A round where investors pay $1.00 per share. Thanks to your discount, your investment converts at a price of just $0.80 per share ($1.00 x (1 - 0.20)). You get more shares for every dollar you invested. Many SAFs include both a valuation cap and a discount, allowing the investor to use whichever term gives them the better outcome (i.e., the lower price per share) at the time of conversion.

SAFs have become popular because they offer distinct advantages for both founders and investors in the fast-paced world of startups.

• Speed and Simplicity: SAFs are often standardized documents, cutting down on legal fees and negotiation time. This allows founders to close funding and get back to building their business.
• Flexibility: It defers the difficult conversation about the company's exact valuation until it's more mature and has more data to support a specific number.
• Not Debt: Since it's not a loan, it doesn't appear as debt on the balance sheet and doesn't have a looming repayment date.

• Quick Execution: In a competitive funding environment, a SAF allows an investor to secure a stake in a promising company quickly, before a deal gets oversubscribed.
• Pro-Investor Terms: The valuation cap and discount are specifically designed to create significant upside potential and reward the risk of investing before a company is proven.

For a disciple of Graham and Dodd, the SAF presents a philosophical puzzle. Value investing is built on the principle of calculating a company's intrinsic value and buying its stock at a significant discount—a margin of safety. A SAF, by its very nature, avoids putting a price on the company today. You are explicitly investing without a known valuation. This makes SAF investing a highly speculative endeavor that sits far from the traditional value investor's comfort zone. The “assets” you're buying are often little more than a great team and a promising idea, not a business with a history of predictable earnings and a strong balance sheet. However, a modern investor might view the SAF through a different lens. While not a classic value play, it is a dominant tool in the high-growth worlds of venture capital and angel investing. For those allocating a small portion of their portfolio to this high-risk, high-reward asset class, understanding the SAF is essential. In this context, the “margin of safety” isn't found in a low price-to-book ratio, but in the protective terms of the SAF itself. The valuation cap and discount rate are the mechanisms that protect your investment from future dilution and create the potential for outsized returns, serving as a unique kind of safety net for the earliest believers in a company's vision.