Since 2013, seed financings in the USA and Asia have often been conducted through a so-called Simple Agreement for Future Equity (SAFE). This is a short standard contract in which an investor provides capital to a startup company and, in return, receives shares at a later date. This article describes the functioning of a SAFE and its implementation under Swiss law.
What is a SAFE?
A SAFE is an agreement between a startup company and an investor in which the investor commits to make an investment after signing the SAFE, and the startup company, in return, agrees to issue shares to the investor at the next financing round. The issue price of these shares is only determined during that financing round. A SAFE is typically indefinite in duration.
The content of a SAFE usually includes the following provisions:
- Triggering Events
Generally, three triggering events are distinguished: If a financing round takes place after the SAFE is concluded, the investor is allocated a certain number of shares. The issue amount corresponds to the issue price of the financing round (with or without a discount), and a valuation cap can be set beforehand. If the company is sold before the financing round (Liquidity Event), it is usually agreed that the investor will receive a certain share of the sale proceeds. Finally, it outlines what happens to the investment if the financing round does not take place, if the company goes bankrupt, or in the event of dissolution (Dissolution Event). - Investor Rights
The SAFE also governs key investor rights before and after the allocation of shares. Preferably, the investor is included early on in an existing or later-to-be-concluded standard shareholder agreement. - Representations
Despite its simplicity, a SAFE typically includes basic representations from both the startup company and the investor.
For more information on SAFEs under U.S. law, refer to the Y Combinator website.
How Can SAFEs Be Implemented in Switzerland?
Under Swiss law, a SAFE can be relatively easily structured as a debt instrument. Accordingly, a convertible loan is created, which is recorded as debt on the company's balance sheet and converted into equity in the next financing round under the agreed conditions. In this case, a subordination agreement from the investor is essential, especially if the liquidity is used for expenses that cannot be capitalized. It should be noted that collective debt financing through a SAFE may, under certain conditions, be classified as a bond for withholding tax purposes, and withholding tax may be due on any interest payments.
As an investor, it is important to ensure that all shareholders agree to the SAFE and the conversion rights stipulated therein. The company cannot unilaterally promise the conversion of debt into equity. This authority generally rests with the general meeting of shareholders, unless there is authorized capital available. Additionally, it is important to consider that existing shareholders have pre-emptive rights, and they must waive these rights for the conversion to take place. Finally, it is advisable to require the investor to join the existing or a future shareholder agreement.
From my perspective, structuring a SAFE as an equity instrument (i.e., without recording an obligation in the company's balance sheet) is challenging. Since the initial investment does not come from an equity holder, it is generally considered taxable income. Whether a provision for the cost of the project to be implemented (analogous to the tax treatment of an equity token by the Swiss Federal Tax Administration) is permissible must be assessed on a case-by-case basis (in consultation with the tax authorities). However, I tend to believe that such a provision would not be permissible. Furthermore, the later issuance of shares to the investor would have to be made from freely available equity (since there is no claim to be offset, and the investor does not want to contribute further funds). This issuance of free shares is typically not feasible for startups due to a lack of freely available equity, and it is often unattractive for tax reasons, as it would generally trigger income tax for the investor and withholding tax for the company.
