How the growth of SAFE investments can lead to a collapse of the startup market

Trying to save their businesses during tough covid times, startup founders are actively looking for alternative ways to raise funds. To speed up and simplify the transaction process, many have chosen the simple and affordable tool SAFE, which stands for Simple Agreement for Future Equity. However, the dominance of SAFE deals may lead to a market collapse in the next year or two, as venture capital funds will begin to deny startups massive funding in the next rounds. 

To understand why such a scenario is very likely to happen, let’s look in detail at how SAFE works. In essence, SAFE is a subscription to owning shares at a price that will be determined in the future. In the UK, a similar transaction format is called ASA, or Advanced Subscription Agreement, in India, called CCD (Compulsorily Convertible Debenture) and such a deal structure can result in tax relief.

A huge plus of SAFEs for startup founders is that they are the only tool that does not give investors any opportunity to influence the company. Investors can participate in business management as part of equity acquisitions, and in the case of a convertible note even file a bankruptcy lawsuit, but by concluding a SAFE deal, they can only patiently wait for the next round of investments when the company’s valuation is agreed upon. Therefore, it is not surprising that many founders are thinking of pursuing SAFE investments. Today we are seeing more and more SAFE deals on the A round, as a result of which founders are left with less than 50% of their companies.

The dilution of the founders’ share is a serious problem, both for themselves and for venture capital funds, which are considering the possibility of investing in the company during the next stages. With each round, the share of founders will become smaller and smaller, and it is likely that they will begin to lose motivation for developing the business. As a result, the founders will try to sell the company as soon as possible, which isn’t the best exit strategy. Venture funds understand this and try not to invest in such companies. This means that startups with many SAFE investors have very sad prospects, regardless of how successfully they overcome the current crisis.

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How the growth of SAFE investments can lead to a collapse of the startup market

The COVID-19 pandemic has naturally made venture capitalists more cautious. Pitchbook analysts estimate that in the first quarter of 2020, the number of venture deals made in the 10 largest countries in Europe almost halved compared to the same period in 2019, from 1363 to 692, although the total investment by VCs grew by 8%.