SAFE (simple agreement for future equity)

Y Combinator (YC) created the SAFE in 2013, and its post-money SAFE has been YC’s standard form since 2018. YC’s SAFE carries no interest and has no maturity date, and its holder has no vote. Until it converts, the holder owns no shares. A SAFE converts when a set event occurs, usually a priced round in which the company sells preferred stock. If no such event happens, a SAFE may never convert.

The number of shares is usually set by a valuation cap, a discount on the new round’s price, or both. The cap is the highest company value the conversion price can be based on. Take a $500,000 SAFE with a $10 million cap. If the round is priced above the cap, the SAFE converts into 5% of the company. That 5% is measured just before the new round’s shares are issued. Under YC’s forms, a sale or wind-down before a round puts the SAFE behind debt and ahead of common stock.

How a SAFE is taxed is unsettled, because no statute, regulation or IRS ruling addresses SAFEs. Advisers generally weigh two readings: the SAFE may be stock, or it may be a prepaid forward contract. Under a forward contract, the investor pays now for shares delivered later. YC’s form says the parties intend the SAFE to be stock for tax purposes. That label does not bind the IRS.

Under either reading, the company is generally not taxed on the money it raises. What the reading changes is when the investor’s holding period starts, including for qualified small business stock (QSBS). If the SAFE is stock, the holding period may start at purchase. If it is a forward contract, the period starts at conversion. For a SAFE bought on or before July 4, 2025 and converted later, the reading can decide which QSBS rules apply.