In the rapidly evolving world of startup funding, SAFE agreements (Simple Agreement for Future Equity) have emerged as a transformative tool, changing the way early-stage companies raise capital. These agreements provide startups with a streamlined path to funding, avoiding the complexities of traditional equity rounds while offering investors a structured framework for potential future equity.
Igor Živkovski, the legal advisor to multinational clients, as well as to many startups in Serbia. He has been practicing law since 2010, he is a partner in Moravčević Vojnović and Partners law office in cooperation with Schoenherr, and in an interview for our blog, he brings us invaluable detailed insights into how SAFE agreements work, what is the position of startups, and what is the position of investors in negotiations, as well as the potential and challenges with regard to the implementation of the SAFE agreements in Serbia.
Reflecting on the benefits, Igor explains that SAFE agreements are gaining popularity worldwide due to their efficiency and adaptability, allowing startups to focus on growth instead of getting bogged down in lengthy negotiations, while investors benefit from early involvement and potential growth in value.
– Currently, Serbian regulations pose challenges for the direct implementation of the SAFE agreements. However, with customized modifications, startups can adopt similar instruments, ensuring compliance while retaining the benefits of a streamlined investment process.
How do SAFE agreements work and what are the main advantages and disadvantages for startups and investors in their implementation?
These characteristics are already clearly visible from the very concept of a SAFE agreement (Simple Agreement for Future Equity) – in short, it represents an investment mechanism according to which the investor pays funds to the startup, and in return obtains the right to acquire a share in it in the future, under certain conditions. Therefore, the mechanism for collecting investment on this basis is relatively simple, which is an advantage for startups, but in the fact that it is a standardized document lies the biggest risk for startups, because any deviations from the usual provisions can introduce uncertainty and potentially subordinate position for a startup in such a way that, through these provisions, the investors will give themselves an advantage in certain segments of cooperation. In any case, it is important to note right away that, although the SAFE agreement is increasingly popular abroad, primarily because of its simplicity, concluding it in Serbia is not possible at the moment, due to the limitations provided by our regulations.
A SAFE agreement is an instrument that is similar in legal nature to a convertible loan. What are the key differences between a SAFE agreement and a convertible loan?
It is a hybrid financial instrument that has been used in Europe for only a few years, and essentially it is an investment agreement between a startup and an investor, which, in the event of the so-called “trigger”, stipulates the conversion of debt into the start-up’s share capital. From a legal point of view, it is not a convertible loan, since convertible loans, as a rule, have a determined maturity day, as well as an interest rate specified (in advance). According to the opinion of most experts (mainly from the United States of America), the SAFE agreement is a warrant by its legal nature. The specificity of the SAFE agreements are the so-called corrective mechanisms for valuation, namely “valuation cap” and “discount”. A “valuation cap” is a predetermined maximum amount of pre-money valuation before the moment of the next investment stage, so that the price at which the conversion will be carried out is lower for the investor with the SAFE agreement (the investor with the SAFE agreement thus gets a larger share in the share capital). A “discount” is a percentage reduction of the conversion price for the investor under the SAFE agreement and generally amounts to 15-20%. The tendency of investing in startups in the last few years has shown that SAFE agreements have a future in the European practice of startup financing, although they were initially used in the United States of America and Canada.
At what stage of startup development is the SAFE agreement the most suitable option for financing?
– By its definition, the SAFE agreement is an investment tool where the investor invests money in a startup at an early stage of development, and later receives a share in the startup with a discount in exchange for the investment made.
Do startups think that using the SAFE agreement will make it difficult for them to get an investment, and do investors avoid this agreement?
– My experience is that startups are very fond of the SAFE agreement, while it cannot be said that investors avoid it, but they are reserved to a certain degree, which is based on the fact that the exit from the SAFE agreement is most often related to the sale of the entire startup, that is, investors can generally sell their investments only when the founders sell the startup, which means that, in that segment, the SAFE agreement provides less flexibility compared to, for example, investing in share capital.
How do SAFE agreements affect startup valuation?
– In two ways – namely, the existence of such an agreement is, on the one hand, a financial obligation of the startup, and on the other hand, it represents a latent change in the ownership structure of the startup, which occurs in the case of the exercise of the investor’s right to acquire a share based on the investment made. Nevertheless, the fact that the startup has already collected an investment through the SAFE agreement is also a positive signal for potential investors because it indicates that there is already someone who has decided to invest in that startup, and it is then really a signal and an indicator that the startup is on the right track and that it has potential for growth and further investments.
Adapting the SAFE Agreement for the Serbian Market
Why are there still legal obstacles when it comes to the use of SAFE agreements in Serbia?
– SAFE agreements are based on issuing additional shares, which limited liability companies (this is the legal form in which startups are mostly established in our country) cannot do in Serbia due to the restrictions prescribed by the Companies Act.
How could startups in Serbia implement the SAFE agreement in their capital raising processes?
– The way to overcome the limitations we pointed out earlier is to reformulate certain provisions of the SAFE agreement in such a manner than it becomes a convertible loan agreement, so that it is accordance with our legal system and eligible for registration at the National Bank of Serbia. I would like to point out that this is mainly about cross-border investments, that is, a loan given by a non-resident, so the money will not even be able to reach a startup registered in Serbia before it is first registered at the National Bank of Serbia. In order for this to be the case, such an agreement must contain certain mandatory elements prescribed by the Foreign Exchange Operations Act and by-laws.
So far, do we have an example of a startup in Serbia that used the SAFE agreement?
– No, given the fact that the regulatory framework does not allow the use of SAFE agreements in Serbia. However, there are many examples of using this agreement as a method of financing parent companies of startups registered in Serbia, both those registered in the United States of America (especially in Delaware), and those registered in Europe (most often in Estonia and the UK).
Experiences
What are the experiences of clients with whom you have worked on SAFE agreements?
– I have worked both with domestic investors who invested in startups registered abroad in this way, as well as with foreign parent companies of Serbian startups. The experiences are very positive – these are the agreements that are quickly and easily implemented, and do not require any additional formalities other than an electronic signature. Also, when it comes to domestic investors, it is particularly positive that transfers on this basis from Serbia to abroad did not encounter problems during realization at domestic banks.
What are the most common problems or misunderstandings startups and investors have when it comes to SAFE agreements?
– The misunderstanding is most often reflected in the fact that startups and investors cannot agree on the valuation, which is certainly one of the most important issues for their mutual relationship. Additionally, SAFE agreements do not contain provisions that regulate this relationship in detail as is the case with the shareholders’ agreement. In this way, a gap is left in that segment from which disagreements can arise, that could negatively reflect on the startup itself.
Legal Protection and Regulations
What legal measures should be taken to protect the interests of startups and investors when using SAFE agreements?
– As unpopular as it may sound, the most appropriate legal measure that needs to be taken in the context of the SAFE agreement is to adapt the standard form of the SAFE agreement to the specific investment in such a manner that the relationship between the startup and the investor will be regulated in the most detailed way so that the legal predictability of such a contractual relationship is reduced to a minimum. Of course, it is impossible to regulate all issues and cover all possible situations with an agreement, but the more thorough it is, the more effectively the interests of both contracting parties will be protected.
How are disputes that may arise from the SAFE agreements resolved?
– Most often by a mutual agreement of the contracting parties, and if this is not possible, then the agreed mechanism for resolving disputes is applied. In practice, it often happens that SAFE agreements do not contain a provision on dispute resolution at all, so it is recommended to pay particular attention to that part and to use arbitration as the most effective way of resolving disputes.
Comparison with Other Instruments
How do SAFE agreements compare with traditional methods of financing startups in Serbia?
– SAFE agreements are usually shorter and less complex than traditional financing documents, which speeds up the negotiation process. This allows startup founders to focus on their business rather than getting bogged down in lengthy funding negotiations.
What are the advantages and disadvantages of SAFE agreements compared to other methods of raising capital, such as angel capital, venture capital, etc.?
– The most important advantage is certainly the speed of collecting the investment through the SAFE agreement. On the other hand, the main drawback is that this instrument is too standardized and it should be taken into account that any deviation from the standard form and content could bring certain risks for the startup that concludes such an agreement. Additionally, there is no period of conversion to share capital.
What are the key factors startups should consider when deciding between a SAFE agreement and traditional venture capital (VC)?
– It is important to keep in mind that the SAFE agreement brings a faster investment and, in this sense, is more suitable for startups that are at the very beginning of development, but there are certain negative sides of this agreement that are primarily reflected in the fact that, due to its use, the startup may have a dispersed ownership structure, which, from that aspect, makes it less attractive to future investors. On the other hand, traditional VC requires longer negotiations and more voluminous transaction documentation, which makes the process of raising capital longer and more difficult, but relations between startups and investors are regulated in more detail, so the chances of misunderstandings are lower.
What would be your general advice to startups that are considering this funding mechanism, and would you rather advise the use of SAFE agreements or venture capital?
– First of all, they should be aware that the SAFE agreement submitted to them by the investor will have to undergo certain amendments and adaptations to Serbian regulations, so that they could accept the investment. In addition, they should pay particular attention to the fact that such amendments do not change the essence of the agreed investment conditions.
– Given that SAFE agreements are not applicable in Serbia, classic VC for a share in the share capital of a startup registered in Serbia is the only option. When it comes to startups registered in Serbia, the parent company of which is registered abroad (for example, in Delaware), my recommendation is to pay attention to certain details, more precisely to deviations from the standard conditions of the SAFE agreement because “the devil’s in the details”