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What is a SAFE ?

A SAFE, or Simple Agreement for Future Equity, represents an option or right to a future stake in a company, triggered by a specific event, such as fundraising. The terms of a SAFE agreement often include a discount rate and/or a valuation cap, helping to protect the initial investor by offering a more favorable conversion price when the shares are converted. 

This type of contract was created in 2013 by Y Combinator to streamline the fundraising process for young start-ups by avoiding the complex valuation assessment of early-stage companies.

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How to calculate the conversion price of the SAFE ?

Note: In this part, we are only talking about the post-money SAFE, which is nowadays the most used SAFE instrument. To understand the difference between pre-money SAFE and post-money SAFE, see the dedicated section below.

The specific feature of a SAFE is that its conversion price is not known at the time of investment, as it depends on the next round of exercise. In fact, the conversion price depends on two parameters : 

• the terms of the SAFE 
• the company's pre-money valuation at the time of the next financing round. 

Let's take a look at some typical SAFE terms examples and the resulting exercise price.

SAFE with a Discount

Here the SAFE Price is calculated by applying the discount to the next round price per share

Let's consider a SAFE investment of $1M contracted in 2020 with a 20% discount. Before SAFE conversion, the company had 1 million shares. At the SAFE investment date, the investor does not know at which valuation they have invested.
Let's also consider that in 2021, the company raises a round at a valuation of $5M.

What will be the price per share paid by the SAFE investor? 

The steps to follow to determine the price per share paid by the SAFE investor are as follows:

1. Determine the PPS paid by the new round investors: The price per share paid by the new investors is the pre-money valuation / the number of company shares before SAFE conversion and the new round, or $5M / 1M = $5.
2. Infer the discounted SAFE investor PPS: SAFE investors benefiting from their 20% discount will pay for each share the price of (1 - discount of the SAFE) * new round PPS, or (1 - 20%) * $5 = $4.

What percentage of the company will be owned by the SAFE investor?

The steps to follow to percentage of the company owned by the SAFE investor are as follows:

1. Determine the number of shares owned by the SAFE investor: The number of shares owned by the SAFE investor is the amount invested by the SAFE investor / the SAFE investor PPS, or $1M / $4 = 250K shares.
2. Determine the total number of shares after SAFE conversion:The total number of shares after SAFE conversion is the number of shares before SAFE conversion + the number of shares owned by the SAFE investor, or 1M + 250K = 1.25M shares.
3. Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the number of shares owned by the SAFE investor / the total number of shares after SAFE conversion, or 250K / 1.25M = 20%.

Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.

SAFE with Valuation Cap

Here, the SAFE price is calculated on the basis of the lowest valuation between the valuation cap and the valuation of the financing round.

Let's consider a SAFE with a $3M valuation cap contracted in 2020 by an investor for $1M. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $5M.

What percentage of the company will be owned by the SAFE investor?

The steps to follow to determine the percentage of the company owned by the SAFE investor are as follows:

1. Determine the valuation for SAFE conversion: The lower of the financing round valuation or the valuation cap is used for the SAFE conversion. Here, the valuation cap ($3M) is lower than the valuation of the financing round ($5M). Therefore, the valuation for SAFE conversion is $3M.
2. Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the amount invested by the SAFE investor / valuation for SAFE conversion, or $1M / $3M = 33%.

Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.

What will be the price per share paid by the SAFE investor ? 

The steps to determine the price per share paid by the SAFE investor are as follows:

1. Determine the total number of shares after the SAFE conversion: The new total of shares is calculated so that the new shares issued represent the % ownership of the SAFE investor, i.e., 33%. The new total number of shares is therefore the total number of shares before the SAFE / (1 - % ownership of the SAFE investor), or 1M / (1 - 33%) = 1.5M shares.
2. Infer the number of shares owned by the SAFE investor: The number of shares held by the SAFE investor is equal to the total number of shares x the SAFE investor's % ownership, or 1.5M x 33% = 500K shares.
3. Calculate the PPS based on the Shares: The price per share paid by the SAFE investor is equal to the amount invested by the SAFE investor / the number of shares owned by the SAFE investors, or $1M / 500K = $2.

What would happen if the financing round valuation was lower than the valuation cap?

If the financing round were $2M, then the $3M cap would not apply because it exceeds the value of the round, and the investor would buy at the same price as the other investors (based on the $2M valuation).

SAFE with Discount and Valuation Cap

If the SAFE contracted by the investor contains both a cap and a discount, the SAFE will be converted to the most attractive PPS.

Therefore, the SAFE Price = min(SAFE with Discount price; SAFE with Valuation Cap price).

SAFE with a Valuation Floor

While the valuation cap is a security for the SAFE investor, guaranteeing them a minimum percentage holding in the next round of financing, it can be risky for founders. Indeed, if the valuation of the next round is lower than expected, the founders may lose a vital part of their ownership to the SAFE investor.
The solution proposed by the SAFE creators to limit this undesirable effect is the valuation floor.

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Here the SAFE price is calculated on the basis of the highest valuation between the valuation floor and the valuation of the financing round.

Let's consider a SAFE with a $3M valuation floor contracted in 2020 by an investor for $1M. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $1.5M.

What percentage of the company will be owned by the SAFE investor?

The steps to follow to determine the percentage of the company owned by the SAFE investor are as follows:

1. Determine the valuation for SAFE conversion: The higher of the financing round valuation or the valuation floor is used for the SAFE conversion. Here, the valuation floor ($3M) is greater than the valuation of the financing round ($1.5M). Therefore, the valuation for SAFE conversion is $3M.
2. Calculate the % ownership of the SAFE investor: The % ownership of the SAFE investor is the amount invested by the SAFE investor / valuation for SAFE conversion, or $1M / $3M = 33%.

Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.

SAFE with MFN

The MFN or Most-Favored Nations clause gives the SAFE investor the right to be aligned with the best SAFE terms (or any other convertible securities) offered in the future by the company.
This clause can be introduced in any type of SAFE contract and applies as long as the SAFE has not ended.
Let's consider a SAFE with a $5M valuation cap and an MFN clause contracted in 2020 by Investor A for $1M.
Let's also consider that in 2021, Investor B has contracted a SAFE with a $4M valuation with the same company for $500K.

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As the terms of Investor B's SAFE are more favorable than those of Investor A, the company has a legal obligation to notify Investor A, who will have the right to requalify their SAFE to obtain a better valuation cap of $4M.

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What are the Key Clauses in SAFE Agreements ?

As their name suggests, SAFEs are simple agreements based on a universal model. However, each investment is unique and each investor/founder should be aware of the main clauses protecting their interests in the event of a SAFE investment.

Let's take a look at the main SAFE clauses

Pro-rata Rights

Pro-rata rights allow the SAFE investor to maintain their ownership percentage in subsequent funding rounds by purchasing additional shares.
The mechanism is as follows: if the company issues new shares, the investor with pro-rata rights has the option to buy enough shares to maintain the same ownership percentage.

Conversion Trigger Events

Different events can trigger the conversion of a SAFE into equity, ensuring the investor receives shares under predetermined conditions.
Conversion typically occurs upon the first of the following events : 

• ‍Equity Financing: Conversion during the next priced equity round, allowing the SAFE to convert into shares at the agreed terms based on the new round’s valuation.‍
• Acquisition: Conversion based on the acquisition price if the company is acquired, enabling SAFE investors to receive shares equivalent to their investment at the acquisition valuation.‍
• IPO: Conversion if the company goes public, with the SAFE converting into shares at the IPO price, giving investors publicly tradable equity.‍
• Change of Control: Conversion upon a significant shift in ownership or management, such as a major sale of shares or a merger, ensuring SAFE investors receive equity in the newly structured company.‍
• Dissolution or Liquidation: Conversion to ensure investors receive equity before asset distribution in the event of liquidation, prioritizing SAFE holders in the payout hierarchy to secure their investment.

Liquidation Preferences

Liquidation preferences specify the order and amount of payments to SAFE holders in the event of liquidation, acquisition, or other liquidity events.
This clause ensures that SAFE investors are compensated before common shareholders if the company is sold or liquidated.

The mechanism is as follows:

1. If a liquidation event occurs, the SAFE holders receive their investment back before any distribution to common shareholders. The payout can be a fixed sum or based on a formula outlined in the SAFE agreement.
2. After the SAFE holders are compensated, any remaining assets are distributed to the other shareholders.

Information Rights

Information rights grant the SAFE investor access to certain financial and operational information about the company.
These rights provide transparency and keep investors informed about the company's performance and financial health.

The commitments of the parties are :

• The company is required to provide regular financial statements, such as quarterly and annual reports, to the SAFE investors.
• SAFE investors can request additional information as specified in the SAFE agreement.
• The investors agree to keep the received information confidential to protect the company’s sensitive data.

Expiration or Termination Conditions

Expiration or termination conditions outline the circumstances under which the SAFE expires or can be terminated.
This clause clarifies the status of the SAFE if no conversion event occurs within a certain timeframe or under specific conditions.

Several scenarios can be covered by the contract :

• The SAFE may have an expiration date, specifying when it will expire if not converted.
• The agreement can also terminate by mutual agreement between the company and the investor.
• Specific conditions, such as failure to raise a new round, can trigger the expiration or termination of the SAFE.

Amendment Clause

This clause ensures that no unilateral changes can be made without the consent of both parties.

How it works:

• Any amendments to the SAFE agreement require written consent from both the company and the investor.
• The process for proposing and approving amendments is outlined in the agreement.
• Changes are documented and signed by both parties to formalize the amendment.

Governing Law

The governing law clause identifies the legal jurisdiction that will govern the interpretation and enforcement of the SAFE. This clause provides a legal framework for resolving disputes and interpreting the agreement.‍

• The SAFE specifies the state or country whose laws will apply to the agreement.
• Legal disputes are resolved according to the laws of the specified jurisdiction.
• Both parties agree to abide by the legal standards of the chosen jurisdiction, ensuring clarity and consistency in legal proceedings.

Pre-money SAFE vs post-money SAFE : What is the difference ?

The main difference between pre-money SAFE and post-money SAFE is the way the ownership rate of the SAFE investor is calculated when the cap valuation is applicable. In the pre-money SAFE, the SAFE investors dilute each other, whereas in the post-money SAFE, each SAFE investor knows their minimum percentage of ownership at conversion.

When the first version of SAFE, the pre-money SAFE, was created by Y Combinator in late 2013, startups were raising smaller amounts of money in advance of raising a priced round of financing (e.g., a series A). What was mainly sought was a simple and fast way to get that first money into the company, and the concept was that SAFE holders were simply early investors in that future round. But early-stage fundraising evolved in the following years, and now startups are raising much larger amounts of money as a first "seed" round of financing. Once the SAFEs had been used for these wholly separate rounds of financing, rather than as "gateways" to subsequent rounds, the initial contract had to be adapted.

The post-money SAFE was created in 2018. It gives the possibility to calculate immediately and precisely how much ownership of the company has been sold, which protects the interests of both SAFE investors and founders.

Let's take a look at two situations to see the difference between SAFE pre-money and SAFE post-money.

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Case of Two Pre-Money SAFEs:

Let's consider a pre-money SAFE with a $5M valuation cap contracted in 2020 by Investor A for $1M and by Investor B for $500K. Before SAFE conversion, the company had 1 million shares.
Let's also consider that in 2021, the company raises a round at a valuation of $10M.

What percentage of the company will be owned by the SAFE investors?

In the case of a pre-money SAFE, the steps to follow are different from those in the “SAFE with Valuation Cap” section:

1. Determine the valuation for SAFE conversion: The lower of the financing round valuation or the valuation cap is used for the SAFE conversion. Here, the valuation cap ($5M) is lower than the valuation of the financing round ($10M). The valuation for SAFE conversion is $5M.
2. Infer the SAFE Investor PPS based on the Valuation: The price per share paid by the SAFE investors is the pre-money valuation / the number of company shares before SAFE conversion, or $5M / 1M = $5.
3. Calculate the number of shares of each SAFE investor: The number of shares of each investor is the amount invested by the SAFE investor / the SAFE investor PPS, or $5. Number of shares of Investor A = $1M / $5 = 200K shares. Number of shares of Investor B = $500K / $5 = 100K shares
4. Calculate the total number of shares after SAFEs conversion: The total number of shares after conversion is the number of company shares before SAFE conversion + the number of shares of each investor, or 1M + (200K + 100K) = 1.3M shares.
5. Calculate the % ownership of of each SAFE investor:The % ownership of the SAFE investor is the number of shares of the SAFE investor / the total number of shares after SAFEs conversion.% ownership of Investor A = 200K / 1.3M = 15.4%% ownership of Investor B = 100K / 1.3M = 7.7%

Note: This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor.

How would Investors A and B be affected if there had been another investor?

Let's consider another SAFE investor, C, who contracted another $1M pre-money SAFE under the same conditions as A and B.

Under these conditions, steps 3, 4, and 5 will have to be reviewed.

Number of shares of SAFE investors:

• Number of shares of Investor A is unchanged: 200K shares
• Number of shares of Investor B is unchanged: 100k shares
• Number of shares of Investor C = $1M / $5 = 200K shares

Total number of shares after SAFEs conversion: The new total number of shares is 1M + (200K + 100K + 200K) = 1.5M shares

% ownership of SAFE investors :

• % ownership of Investor A = 200K / 1.5M = 13.3%
• % ownership of Investor B = 100K / 1.5M = 6.7%
• % ownership of Investor C = 200K / 1.5M = 13.3%     

The impact of SAFE investor C has therefore been to reduce the ownership rate of Investor A from 15.4% to 13.3% and of Investor B from 7.7% to 6.7%.

‍We can see that in the case of pre-money SAFEs, SAFE investors influence each other's ownership rates.

Case of Two Post-Money SAFEs

Let's consider a post-money SAFE with a $5M valuation cap contracted in 2020 by Investor A for $1M and by Investor B for $500K. Before SAFE conversion, the company had 1 million shares.

What percentage of the company will be owned by the SAFE investors?

In the case of a post-money SAFE, the minimum percentage of SAFE investors can be calculated immediately when the SAFE is contracted using the valuation cap:

The percentage of shares guaranteed to SAFE investors is the amount invested by the SAFE investor / the post-money valuation cap.
% ownership of SAFE investors:

• % ownership of Investor A = $1M / $5M = 20%
• % ownership of Investor B = $500K / $5M = 10%
  
  

The SAFE investors' effective holding percentage is calculated at the time of the next equity round on the basis of the lowest valuation between the valuation cap and the valuation of the financing round.For more details, see the section "SAFE with Valuation Cap."

NB : This is the ownership of the SAFE investor one instant before the financing round. The SAFE investor will then be subject to dilution during the equity round like any other investor. 

How would investors A and B be affected if there had been another investor?

Let's consider another SAFE investor, C, who contracted another $1M post-money SAFE under the same conditions as A and B.

In the case of post-money SAFEs, the percentage of shares guaranteed to investors A and B remains the same.

% ownership of SAFE investors:

• % ownership of Investor A = $1M / $5M = 20%
• % ownership of Investor B = $500K / $5M = 10%
• % ownership of Investor C = $1M / $5M = 20%

‍We can see that in the case of post-money SAFEs, SAFE investors don't influence each other's ownership rates.

What is a BSA AIR and how does it differ from the SAFE?

The BSA AIR is the French equivalent of the SAFE; it stands for ​​Bon de Souscription d'Actions par Accord d'Investissement Rapide. Like its American counterpart, the BSA AIR provides a future right to equity, its conversion price is indexed to the following equity round and can include a discount, a valuation cap, and/or a valuation floor.

Although similar to the American SAFE, the BSA AIR was developed in a different jurisdiction and therefore contains some notable differences that everyone should bear in mind before using it:‍

• ‍If nothing happens, the BSA AIR is still converted 

Unlike the SAFE, the BSA AIR offers conversion of the investment into shares on a specific date if no triggering event, such as a fundraising, occurs before that date. This conversion is calculated on the basis of an alternative valuation, which may correspond to the Valuation Cap, Valuation Floor, or a median value. In the basic model proposed by its creator, Sacha Benichou, an attorney at the Paris Bar, this date is set at 24 months after the subscription date and sets the alternative exit value at the median value between the Valuation Cap and the Valuation Floor.‍

• ‍The BSA AIR allows transfer of ownership‍

Unlike the SAFE, where transfer of ownership is only possible by mutual agreement between the investor and the company, the right to transfer the BSA AIR is set out in the terms of the contract and may be authorized or prohibited according to the wishes of the contracting parties.

• ‍The BSA does not offer preferential liquidation

In the event of an exit (buyout, IPO or SAFEguard procedure), the BSA-AIR does not include a preferential liquidation clause, unlike the SAFE. This clause entitles the investor to priority repayment, ahead of the other shareholders.

VC funds have an emerging question when running startup valuations: how can they integrate startup recent efforts to balance growth and cost efficiency into the valuation of the company?

To try to answer this question, Datasset is building a new valuation model “the Burning Math” that tries to reflect these efficient growth efforts into the startup valuation.  

Since we entered the Ice Age of financing in 2022, cash is not anymore pouring into the venture world. Therefore, startups no longer focus only on increasing revenues. They rather work hard on having an “Efficient Growth”, meaning a sustained revenue growth coupled with a thoughtful cost control in order to reduce their reliance on external financings. In a nutshell, “doing more with less”.

This industry shift has a direct impact on startup valuation models. Prior to this venture capital cash shortage, revenue multiple - and more specifically Annual Recurring Revenues (ARR) multiple for SaaS companies - was the key metric used by VC funds to assess the valuation of a company.

Considering the increasing value-added of Efficient Growth during this macroeconomic downturn, valuation models should catch-up with updated models that directly integrate these cost control efforts in the balance.

To determine how VC funds should integrate Efficient Growth into their startup valuation models, we need:

1. first to define what we precisely mean by Efficient Growth
2. determine which metric can better reflect this Startup Efficient Growth
3. Propose a new framework which integrates Efficient Growth into startup valuation

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How to define Startup Efficient Growth?

Startup Efficient Growth means finding the correct mix between revenue growth and cost control that will allow the startup to scale while being profitable in the long run.

Yet, because revenues and expenses are interconnected, finding the right balance between these two indicators is crucial and tricky.

• “Crucial” because at an early stage, expenses growth is not proportional to revenue growth. Therefore, every expenditure must be strategically allocated to bridge this initial gap between expense and revenue growth.
• “Tricky” because expenses are an intrinsic factor of growth. At an early stage, opting for a short-term cash conservative approach may slow down revenue growth and hit profitability down the road.  

Therefore, selecting the right metric to assess Efficient Growth is essential to make sure we capture adequately the startup effort to combine revenue growth and cost control into its valuation.

Which metric better assesses Efficient Growth for startups?

The Rule of 40 - what it is and why it is inadequate for early stage startups

I see an increasing number of startups reporting to investors their own Rule of 40 which is a total nonsense.

The 40% rule is calculated as follows:

Company growth rate (revenue YoY growth rate) + Company profit (or EBITDA margin) should add up to 40%.

It was brought in 2015 by the iconic Brad Feld (see his original article The Rule of 40% For a Healthy SaaS Company) to assess the good mix between revenue growth and EBITDA margin for late stage companies. Brad Feld explicits it clearly - “if you are going to raise VC money, get focused [...] on scale, then start focusing on the 40% rule”.

Indeed, the Rule of 40 is putting an emphasis on being profitable which is inappropriate for most early stage venture and growth startups. At an early stage, startups need first to invest in order to create revenues. Deficit is structural and should not be penalized.

Bottom line: the Rule of 40 was more conceived to fit scale-up rather than startup models. Even worse - trying to apply the Rule of 40 to startups can kill both their growth & profitability.

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The Rule of X - getting closer to Startup Efficient Growth assessment

Bessemer Venture Partners published a great paper in January 2024 announcing the Rule of 40 math is dead wrong. Byron Deeter and Sam Bondy point out that assigning equal weighting to growth and profitability is wrong. Growth should have priority over Profitability and should be weighted between 2 and 3 depending on the company stage.

The Rule of X, which fine-tunes the Rule of 40, has two main advantages:

1. It puts an emphasis on growth over profitability
2. It creates buckets with different weights applying on the Rule of 40 depending on the company stage

Yet, this interesting framework only applies to mid / late stage companies. Then, how can we measure Efficient Growth for startups that are pre-seed to Series-B / C companies? Bessemer Venture Partners advises to look at the Burn multiple. Let’s dig into it.

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The Burn Multiple - the perfect KPI match for Startup Efficient Growth assessment

The Burn Multiple is a very interesting tool for startups. It was put together by David Sacks in his article the burn multiple, largely inspired by the Efficiency Score of Bessemer Venture Partners. It computes as follows:

It has three great interests:

1. It better fits early stage companies as it gets away from a profit driven approach
2. It puts a focus on good use of funds
3. It takes a marginal approach, meaning it looks at the effect of 1 additional dollar spent on extra revenues.

Sacks goes further, by offering a “rule of thumb” to assess what is a “good” burn multiple.

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Burn Multiple by ARR of a16z - a more refined model for Efficient Growth assessment based on ARR level

Andressen Horowitz proposed an even more refined framework based on a16z private data, in an article titled A framework for Navigating Down Markets

It lays-down guidelines on the appropriate Burn Multiple depending on the ARR level, creating different buckets of burn multiple performances based on ARR level.  

There are 3 main advantages to a16z model:

• the expected burn multiple should depend on ARR level and company development
• the more the startup grows, the more it should put a focus on reducing its burn multiple
• it covers a large spectrum of startups, from early stage companies with ARR below $10m up to startups with over +$75m ARR.

Introducing The Burning Math for startup valuation

Datasset proposes a new model for valuation of SaaS companies, the “Burning Math”. The goal of this model is to integrate Efficient Growth into early stage valuation assessment.

How does it work?

1. Set an initial valuation applying classic multiple benchmarks to the current ARR level
2. Calculate the startup average Burn Multiple over the last 3 months to mitigate cyclical expenses
3. Determine in which bucket the startups falls depending on its ARR level
4. Apply a 25% bonus / discount on valuation, depending on whether the startup fall into the good / bad bucket

You finally get a valuation that is anchored into an ARR multiple approach, but that directly integrates Efficient Growth.

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This Burning Math is an initial “rule of thumbs”. It needs to be tested with VCs eager to submit data sets to fine tune these initial hypotheses. We look forward to publishing an upcoming paper sharing our results.

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Early-stage investors should expect the highest ROI because:

• They bear the highest risks, investing in startups before success is proven.
• They invest earlier, resulting in a mechanically lower IRR than later-stage investors.
• They typically face higher risks of dilution, liquidity preferences, and more.

Traditional exit paths include:

• IPOs
• M&As (by another company, equity, or LBO fund)

However, IPOs and M&As have become less relevant for early-stage investors. Secondary transactions are now more popular, and if you are an early investor, you should definitely focus on this track! We tell you why, and how.

1. IPOs

IPOs have significantly reduced in volume and proceeds compared to 2020-2021, although there has been a slight catch-up in early 2024. This slowdown in IPOs has a major impact on proceed expectations since IPOs typically offer multiples that are 40% higher than other cash-out alternatives.

2. M&As

Since mid-2022, M&A activity has also declined in both number and value. Increasingly, M&As are being executed at lower valuations than the last funding round, negatively affecting investors' expected proceeds.

Early-stage investors are especially impacted by these lower valuations in M&A transactions. Typically, early investors hold common shares, whereas later investors negotiate preferred shares, which come with liquidity preferences (e.g., 1x, 2x). If an acquisition happens at a valuation lower than the last round, preferred shareholders have priority in receiving proceeds. Consequently, early investors with common shares (often pre-seed/seed investors) may not receive any proceeds from their investment.

3. Secondary transactions

The third option for early-stage investors to monetize their investments before an exit is through secondary market sales. The advantages include exiting earlier, setting the terms, and potentially maximizing ROI and IRR. 

Here is a guide in four rules we put together to help you maximize your investment returns.

‍Rule 1: Prepare your secondary - Understand the terms

‍Most difficulties in secondary transactions can be avoided by considering exit strategies during the initial investment discussions. An investor will find a smoother path to exit through a secondary sale if the investors takes it into account when signing the terms, avoiding any deterring conditions for secondary buyers.

Understand the implications of your investment contract

Depending on the type of investment contract, you will have varying degrees of flexibility.

‍Direct Investment‍

The most straightforward case: the investor directly owns shares in the startup. Subject to the conditions discussed below, you can freely transfer shares to other private investors.

‍SPV (Special Purpose Vehicle)

• Flexibility: An SPV offers more secondary flexibility than direct investment. Approval is needed from the SPV representative, not the startup board. Secondary terms are often defined in the SPV agreement and are usually less sensitive since they don’t create governance issues for the startup.
• Drawbacks: Selling shares of an SPV may be less attractive because:
  • You have no say if the startup allows shareholders to conduct secondary sales; this decision is made at the SPV representative level.
  • There is usually a carry, which negatively impacts potential proceeds and thus the sale price.

‍SAFE (Simple Agreement for Future Equity)

‍Typically, a SAFE is not transferable (check your SAFE terms to confirm this). Until a conversion event occurs (generally an equity financing), secondary sales are not possible. However, there are different ways to monetize a SAFE, which we will discuss in another article.

Be aware of the key legal terms impacting potential secondary transactions

When investing, there are various terms you may accept without fully understanding their impact on secondary transactions. Depending on when you invest and your negotiating power, you can either oppose certain terms or at least be aware of their potential risks.

• The Right of First Refusal (ROFR) (or “Pre-emptive right”)

When a shareholder engages in a secondary transaction process, he needs to notify the other shareholders of this transaction. The ROFR gives the other shareholders the right to pre-empt this transaction and buy.

Risk

This right can deter potential buyers from engaging in the transaction. Secondary investors may fear investing time and resources into due diligence and sales discussions only for the transaction to be pre-empted by others.

Additionally, if they are some rights associated with certain ownership thresholds and the secondary buyer ends up.

Tips

‍Anticipate discussions: Talk to founders and other shareholders early to gauge their willingness to accept or pre-empt a secondary transaction. This helps build your case in the event of a conflict.

‍Opt for ROFO: Consider a Right of First Offer (ROFO) instead of ROFR. This inverts the sales process: you first offer your shares to existing shareholders at a predefined price. If no one shows interest, you can offer them to third parties without risking preemptive opposition.. 

• The Liquidity Provision

A liquidity clause requires the founders to offer a liquidity solution for the investors (e.g., through an IPO, a buyout via an LBO, or appointing an investment bank to find a buyer) within a defined timeframe (generally 5 to 7 years after the investment).

Tip

Many founders fear such provisions as they may feel pressured to sell. Always understand the founder’s perspective and try to find a compromise, such as a price threshold or other provisions that assure the founders this clause won’t be used against the company's interests.

• Shareholder Agreement authorisation mechanisms 

Shareholder / Board authorization mechanisms may be explicit in investment agreement or shareholder agreement. Sometimes, this authorization mechanism may be less explicit. You may either find it in other legal documents, such as the company’s organizational documents or corporate law in the relevant jurisdiction. Other indirect approvals include:

• Inadvertent Triggering of Liquidation Waterfall: A change in control may trigger liquidation.
• Free Transfers: If the secondary sale does not fall into the Free Transfer list defined in the shareholder agreement, board approval cannot be waived.
• Non-compete provisions: These prevent shareholders from investing in companies with competing business activities and may deter secondary sales to certain shareholders.

Tips

There are legal “tricks” to avoid these selling restrictions, such as:

‍Upstream transfer: If shares aren’t owned directly but owned by an entity, the secondary buyer may acquire the holding company or part of it.

‍Total return swap: The buyer and the seller can set up an arrangement that provides the seller with indirect economics of a direct investment. In the event of liquidity, proceeds may be transferred directly to the secondary buyer under the total return swap agreement.

Risks

These tips come with potential risks, including:

• Complexity and cost of structuring such agreements
• Increased risk for the buyer, especially with total return swaps
• Opposition to these legal structures under the shareholder agreement

‍Rule 2: Chose the good timing

‍The optimal timing is usually in parallel with a fundraising round for four main reasons:

• Valuation: Founders may be reluctant to authorize transactions that set a price for their company, potentially contradicting their valuation rationale.
• Data Room: Secondary buyers often require confidential data to inform their investment decisions. Outside of a fundraising process, startups generally won’t have this data readily available to share.
• Opportunities Created by Financial Rounds: Startups may use financial rounds to trigger secondary processes, either offering a mix of primary and secondary shares to new investors or providing liquidity for their employees or themselves.
• Suboptimal Sales Outside Rounds: Outside of a financial round, any sale is likely to be suboptimal. If the price is lower than the share value, it will be pre-empted. If it is higher, the buyer gets a bad deal, which isn't attractive.

‍Identify the Best Round to Exit Depending on Your Investor Type

‍Generally, the best round to exit for an early-stage investor is around Series B because:

• Before this, you are still in the early stage of the process. Leaving at this stage may be seen as a lack of trust and support in the project.
• Considering the risks taken at pre-seed/seed stages, the expected return may be less attractive than exiting after Series B.
• From Series B onwards, you may face higher dilution risks with more sophisticated funds entering, bringing more sophisticated terms (such as ratchets or preferred shares) that may be detrimental to early-stage investors.

‍Communicating ahead of time with the startup

‍Define clear expectations with the startup you invested in. They are your best allies in envisioning a liquidity event:

• They may receive offers from potential buyers interested in a secondary sale.
• It pushes them to build a liquidity scenario for their investors.
• They may structure the upcoming fundraising with a portion coming from secondary sales.
• It may encourage founders looking for personal liquidity to organize a secondary process for themselves and investors.

Getting the startup's support in the secondary transaction is essential to create your secondary data room and share relevant and accurate information with potential buyers.

• Why can a secondary come to you before you even asked for it: When a startup gets more mature, several reasons can push founders to consider a secondary scenario:

‍Why a Secondary Sale Might Come to You Before You Ask for It

‍As a startup matures, several reasons might push founders to consider a secondary scenario:

1. Cap Table Cleanup: Founders may need to clean the cap table ahead of a financing round. Early stages often involve many different business angels, which can deter professional funds. Many investors on the cap table mean slower decision processes, heavier administrative burdens, and increased shareholder management frictions. Options include:some text
   • Offering new investors the chance to buy these shares on the secondary market at a discounted price.
   • Constituting an SPV to hold all business angel shares to facilitate management.
   • Proceeding with a share buyback to decrease the number of shares and increase ownership for remaining shareholders.
2. Love Money Investors: Founders may want to provide liquidity options to early supporters who invested out of "love" rather than rational investment. Even if you are not one of these investors, you may benefit from tag-along mechanisms allowing an early exit.
3. Negotiation Leverage During New Funding Rounds: While founders may resist decreasing the new round valuation, they may negotiate the actual price by offering a mix of primary financing at the defined company valuation and secondary financing at a discount, justified by lower liquidity and investor interest to sell.
4. Provide Liquidity to Employees: Being an attractive employer is crucial for success. Compensation is a central part of the company’s strategy to attract, satisfy, and retain talent. Therefore, secondary pool liquidation can be coordinated with the sale of historical shareholder stakes to provide liquidity to employees. This approach helps maintain a motivated workforce and aligns employee interests with the company’s growth and success.

‍Rule 3: Set the right price

‍When a secondary path is identified, the seller needs to structure the offer. Once potential buyers are identified and selling barriers are cleared, the next challenge is to set the right price. There are two main types of parameters to integrate into the pricing process:

Timing

• In Parallel with a Financing Round:‍
  • Use the fundraising valuation as the starting point. This provides a current and market-validated valuation reference.
  • Apply a discount to this valuation to account for the fact that secondary transactions typically involve less liquidity and higher risk compared to primary financing. The discount rate can vary depending on market conditions, the specific characteristics of the shares being sold, and the urgency of the sale.

• Out of a Financing Cycle:‍
  • Use the most recent valuation as a benchmark. This valuation should be adjusted based on the startup's current fundamentals
  • Adjust the price according to the type of shares being sold (discussed below).

Ultimately, the price is an adjustment between supply and demand. Valuation will be influenced by the fundamentals and the interest level among buyers versus the quantity of shares available for sale. In periods of high demand, prices might be closer to primary market valuations, whereas in times of low demand, discounts may need to be steeper.

Characteristics of the Shares

• Share Class:
  • Common Shares: These typically have less seniority compared to preferred shares. In a liquidation event, common shareholders are paid after preferred shareholders, which usually means a higher risk for common shareholders.
  • Preferred Shares: These often come with liquidation preferences, meaning preferred shareholders get paid before common shareholders. This seniority can make preferred shares more valuable and less risky, often justifying a higher price.
• Rights Related to the Shares:
  • Corporate Rights: Shares with voting rights or board representation can be more valuable as they provide more control over the company’s decisions.
  • Shareholding Rights: Shares with additional rights, such as anti-dilution provisions (ratchets) or the ability to participate in future financings, can command a higher price.
  • Dividend Rights: Shares entitled to dividends might be more attractive to buyers looking for income as well as capital appreciation.

In practice, setting the right price involves balancing these factors to reach an agreement that reflects both the seller's and buyer's perspectives. Sellers should be prepared to justify their pricing based on a thorough understanding of the company's financial health, market conditions, and the specific attributes of the shares being sold. Buyers, on the other hand, will weigh these factors against their investment criteria and risk tolerance.

‍Rule 4: Build your selling strategy

‍Building the strategy

Building a successful secondary strategy requires careful planning and consideration of multiple factors. These include understanding the market conditions, aligning with the startup's fundraising cycles, setting an appropriate price, and ensuring compliance with any contractual obligations. Here are the key steps:

• Strategic Planning: Develop a clear plan that outlines your objectives, the desired timing for the sale, and the expected financial outcomes. This plan should also consider any potential obstacles and strategies to mitigate them.
• Legal and Contractual Review: Ensure that your proposed secondary sale complies with all relevant legal and contractual requirements. This includes reviewing the shareholder agreement, investment contracts, and any other pertinent documents.
• Collaboration with Stakeholders: Communicate your intentions with the startup’s founders and other key stakeholders. Gaining their support can facilitate a smoother transaction and access to necessary information.
• Market Research: Conduct thorough research to understand the current market conditions and demand for secondary shares in your specific sector. This will help you set a realistic price and identify potential buyers.
• Documentation and Preparation: Prepare all necessary documentation, including a detailed information memorandum, financial statements, and any other materials that potential buyers might require for their due diligence.

The Datasset team can assist you in running this process efficiently. Reach out to us so we can work together to determine the best approach for your specific situation.

Identifying the Buyer‍

Finding the right buyer is crucial for a successful secondary sale. Here are some strategies to help identify potential buyers:

• Secondary Platforms and Funds: Leveraging a secondary platform or fund can streamline the process of finding a buyer. These platforms and funds specialize in secondary transactions and have extensive networks of potential buyers.some text
  • Top Platforms/Funds: Datasset has identified the top 10 secondary platforms and funds that can help you find a buyer more easily. These platforms offer access to a broad range of investors, including institutional investors, family offices, and high-net-worth individuals interested in secondary market opportunities.
• Direct Outreach: In addition to using platforms, consider reaching out directly to potential buyers who have shown interest in similar opportunities. This can include existing investors in the startup, strategic investors in the industry, or other venture capital funds.
• Networking: Utilize your professional network to identify and connect with potential buyers. Networking events, industry conferences, and personal connections can be valuable resources for finding interested parties.
• Advisors and Brokers: Engage advisors or brokers who specialize in secondary transactions. They can leverage their expertise and networks to help you find and negotiate with potential buyers.

If you want to get a list of the 10 best platforms/funds identified by Datasset, please reach out to us. We are here to support you through every step of your secondary transaction process.