Simple Agreements for Future Equity (SAFE) have become a key financing instrument for funding startups around the world. This article explores the details of SAFE agreements, focusing on their legal status and use in Armenia. As Armenia’s tech sector grows rapidly, it’s important for entrepreneurs, investors to understand SAFE agreements. Recent changes in Armenian laws highlight the importance of these financial tools in encouraging innovation and economic growth.
What is a SAFE Agreement?
A SAFE agreement is a legally binding document that governs the relationship between an investor and a company. Unlike traditional equity or debt financing, a SAFE is a unique hybrid that allows a company to raise funds without immediately issuing equity or incurring debt. Instead, it provides investors with the right to convert their investment into preferred shares at a future date, typically upon the occurrence of specific triggering events such as a funding round, acquisition, or IPO.
Legal Framework of SAFE Agreements in Armenia
Safe agreements are considered a new legal mechanism in Armenia’s legislation, established by the 2024 amendment to the “Law on Joint-Stock Companies” of the Republic of Armenia, which defined them as securities in Article 38.2, Paragraph 7.
According to Article 38.2, Paragraph 1, of the “Law on Joint-Stock Companies” of the Republic of Armenia: The investor, as one party, undertakes to invest a specified amount into the company’s equity, and the company, as the other party, undertakes to issue and allocate shares in favor of the investor a specified number, type, and class of shares at a future date, upon the fulfillment of the conditions specified in the agreement.
According to the Law on Joint-Stock Companies, SAFE agreements in Armenia include several essential elements:
- The investor undertakes to invest the amount specified in the agreement, and the company undertakes to issue shares in the event of the fulfillment of the conditions provided for in the Safe agreement.
- The investor transfers the funds, and the issuance of shares is carried out upon the fulfillment of the conditions.
- In the event of the fulfillment of the conditions, the company is obliged to issue the shares within 60 days.
- The pre-emptive right of shareholders does not apply in the case of the exercise of the rights of investors provided for in the Safe agreement.
- The Safe agreement may provide for the return of the invested funds and the payment of interest.
SAFE Agreements and LLCs in Armenia
The “Law on Limited Liability Companies” of the Republic of Armenia, in Article 27, states that a company has the right to issue securities, except for shares, in the manner prescribed by law.
Based on the analysis of the above-referenced norms, LLCs in Armenia do not have the legal possibility to enter into SAFE agreements, as the law only provides for the right to purchase shares in the context of Safe agreements, while LLCs are not authorized to issue shares. In contrast, Armenian law allows SAFE agreements specifically for joint-stock companies, which can issue shares and therefore enter into these types of agreements.
However, the Civil Code of the Republic of Armenia does not prohibit the conclusion of other agreements not provided for by the Civil Code and not contradicting the law. Therefore, although there is no legal possibility to conclude SAFE agreements, it is not prohibited for LLC participants and investors to enter into a similar transaction, which, in the context of the Civil Code of the Republic of Armenia, will be considered a mixed contract in accordance with the provisions of Article 293 (transaction with a suspensive condition) and Article 445 (preliminary contract). Within this framework, it is possible to establish provisions arising from the nature of SAFE agreements, but in this case, the obligation should be to sell the company’s shares to the extent provided for in the contract, rather than the obligation to distribute the company’s shares, as in the case of SAFE agreements.
Commercial Implications
SAFE agreements can contain several key components that have significant commercial implications:
Valuation Cap
The valuation cap is a crucial component of a SAFE agreement. It represents the maximum company valuation predetermined in the SAFE. This cap serves as a ceiling for the company’s value, and it is used to determine the conversion price of the SAFE into equity.
If the company’s valuation exceeds the cap in a subsequent round of funding, the investor will be entitled to its proportionate share of the company and to an allotment of shares as if the company valuation were lower, i.e., at the cap value. This mechanism protects the investor from being diluted if the company’s value increases significantly in the future.
For example, if a SAFE has a valuation cap of $5 million and the company later raises a funding round at a $10 million valuation, the SAFE investor will receive shares as if the company was valued at $5 million, rather than the actual $10 million valuation. This ensures the investor receives a larger equity stake than they would have if the conversion was based on the higher valuation.
Pre-Money and Post-Money Valuation
When discussing the valuation cap in a SAFE agreement, it’s important to understand the concepts of pre-money and post-money valuation. Pre-money valuation refers to the value of the company before the current round of investment. This is the baseline value of the company that the SAFE valuation cap is based on. Post-money valuation, on the other hand, is the value of the company after the current round of investment. This includes the new capital raised, which increases the overall value of the company. The SAFE valuation cap is typically set based on the pre-money valuation, as it represents the company’s value before the new investment. This ensures that the SAFE investor’s equity stake is calculated based on the company’s value prior to the additional funding.
Discount Rate
The discount rate is another key component of a SAFE agreement. It provides the investor with a percentage discount on the valuation of the next financing round when calculating the conversion price. This discount rate offers additional protection to the investor by compensating for the risk taken by investing early. The discount rate is typically expressed as a percentage, such as 20%. This means that when the SAFE converts into equity during the next funding round, the investor will receive shares at a 20% discount to the valuation of that round.
For instance, if the next funding round values the company at $10 million, and the SAFE has a 20% discount rate, the investor will receive shares as if the company was valued at $8 million (a 20% discount from the $10 million valuation). This ensures the investor receives a more favorable equity position compared to the new investors in the subsequent round.
Conversion Mechanics
The conversion mechanics of a SAFE outline the specific events that trigger the conversion of the SAFE into equity. These events are typically tied to the company’s future financing activities, such as a subsequent funding round or an acquisition.
The SAFE agreement will specify the exact conditions that will cause the SAFE to convert, such as the company raising a certain amount of capital in a new funding round or the occurrence of a liquidity event, such as an acquisition or an initial public offering (IPO).
Most Favored Nation (MFN) Clauses
Most Favored Nation (MFN) clauses are an additional layer of protection for SAFE investors. These clauses ensure that if the company issues SAFEs with more favorable terms to future investors, those terms will automatically apply to the existing SAFEs as well. MFN clauses help prevent the company from offering better deals to later investors, which could disadvantage the earlier SAFE holders.
SAFEs have emerged as a powerful tool in the startup funding landscape, offering flexibility and simplicity for both entrepreneurs and investors. Armenia’s recent legal recognition of SAFEs underscores their global traction in supporting innovation and economic growth. Entrepreneurs and investors should consider the strategic use of SAFEs to secure funding and protect their interests. While SAFEs offer flexibility for joint-stock companies, their use is currently limited for LLCs in Armenia. However, similar arrangements can be structured within the existing legal framework, offering a pathway for startups to access this innovative funding mechanism.
If you’re seeking expert guidance on structuring and negotiating SAFE agreements, Retrieve Legal and Tax is here to assist you. Our experienced legal team specializes in supporting both companies and investors in developing agreements that protect their interests and promote successful financial partnerships.