Investment Agreements: SAFEs and Convertible Instruments from a Legal Angle

The distinction isn't academic. An instrument that is economically sound but poorly drafted produces a dispute at conversion — the worst possible moment.

1. What is a SAFE?

SAFE stands for Simple Agreement for Future Equity. It is an agreement between the company and an investor under which the investor pays an amount today in exchange for the right to receive shares upon a future priced round.

It originated in the United States as a simplified alternative to convertible notes, deferring valuation negotiations until more data exists. It became popular for its speed and low cost at early stage.

Core characteristics:
- It isn't debt in origin: no interest, no maturity, no repayment claim.
- It confers no shareholder status before conversion — no voting rights, no dividends.
- It converts into shares on a defined event: a priced round, or a sale of the company, according to an agreed mechanism.

2. The critical legal point: local adaptation

This is where most circulating content falls short. The SAFE was designed within a common-law system that differs from the one applicable locally. In civil-law jurisdictions it may be construed as a "promise to contract" rather than as a deferred equity instrument. For that reason it is advisable to adapt it legally so that it conforms to the local Companies Law and secures the right of priority in the issuance of shares on conversion.

The practical consequence: do not copy a foreign template and sign it as-is. What to confirm with counsel:

• The share issuance mechanism at conversion: can the company's legal form accommodate it? A form that divides capital into shares and permits multiple classes is better able to absorb these instruments than one that doesn't.
• The approvals required to issue new shares, and assurance they cannot later be blocked by a shareholder.
• Consistency between the agreement, the articles of association, and the founders' agreement.
• What happens if no conversion event ever occurs — the absence of this provision is among the most common sources of ambiguity.
• Dispute resolution and governing law.

3. Convertible notes

Similar in purpose, different in nature: a debt instrument convertible into shares at a subsequent funding round, carrying interest and a maturity date, with repayment potentially demandable if conversion doesn't occur.

Legally, that nature means the company carries a financial liability on its books, and the investor occupies a different position in the order of priority on liquidation. Heavier on the company, more protective of the investor.

4. The practical trap: stacking instruments

A risk that warrants an explicit warning: if a founder raises multiple rounds through convertible instruments without conducting a priced round, they may discover at conversion that the combined investor percentages leave founders with very little ownership — potentially weakening their incentive and making the company unattractive to later investment.

The preventive measure: maintain a simulation table, updated after every instrument, showing expected ownership percentages at conversion across different valuation scenarios. Don't sign a new instrument before seeing its cumulative effect in that table.

5. Term sheet: binding or not?

A term sheet summarises the principal terms before final documents are prepared. Most of its provisions are ordinarily non-binding, with specific exceptions typically drafted as binding: confidentiality, exclusivity in negotiations for a defined period, and allocation of expenses.

Confirm expressly: which provisions are binding and which aren't, and the duration of exclusivity — signing a long exclusivity freezes your conversations with other investors and weakens your position if the deal stalls.

6. Priced round documents

When moving to a priced round, a broader document set appears:

• Subscription or share purchase agreement: the amount, the number of shares, and the representations and warranties given by the company and founders.
• Shareholders' agreement: governance, board composition, protective provisions, share transfer restrictions, tag-along and drag-along rights, and pro-rata rights.
• Amended articles of association consistent with what was agreed.
• Vesting documents for founders.
• Conditions precedent to closing: what must be completed before funds transfer — correcting the cap table, assigning intellectual property, completing licences, or resolving outstanding commitments.

7. Representations and warranties

Provisions in which founders confirm the accuracy of specified information about the company. An inaccurate representation may create personal liability. Read them with particular care, and disclose any exception in the disclosure schedule rather than omitting it — disclosure protects you; omission exposes you.

Common mistakes

• Copying a foreign SAFE template without local adaptation.
• Stacking convertible instruments without modelling their cumulative effect.
• Omitting the provision for no conversion event occurring.
• Signing a long exclusivity in the term sheet.
• Inconsistency between round documents and the articles or founders' agreement.
• Unexamined representations and warranties with no disclosure schedule.
• Relying on the other side's counsel instead of independent advice.

Checklist

• Instrument selected with awareness of its legal nature
• Agreement adapted to local law by licensed counsel
• Confirmation the legal form can accommodate conversion
• An express provision for no conversion event occurring
• An updated cumulative-effect simulation table
• Binding provisions in the term sheet identified, and exclusivity duration
• Consistency of all documents with the articles of association
• Representations and warranties reviewed and a disclosure schedule prepared
• Conditions precedent satisfied before transfer
• Legal counsel independent of the investor

FAQ

Is a SAFE usable locally?
It is used in practice, but sound practice is to adapt it legally to conform with the local Companies Law rather than transplanting it verbatim.

How does it differ from a convertible note?
The former isn't debt and has no maturity; the latter is debt carrying interest and a maturity date, and repayment may be demanded.

When does it convert into shares?
On the agreed conversion event — usually a priced round or a sale of the company — applying the specified cap or discount.

Do I need counsel for a small instrument?
Yes. A small instrument produces a large effect at conversion, and the preventive cost is far below the cost of a dispute.