What is a CHEST? • Benzinga


When looking at seed investments, you are likely to come across offers issuing a SAFE or simple deal for future equity. Read on to learn about this type of instrument and how it works.

Getting into a startup that grows into an industry titan early is pretty much the ultimate object of desire for any investor. This makes a lot of sense when you think about how a single investment in the right startup can create generational wealth. However, one of the reasons why investing in startups is highly profitable is that the profit potential comes with a very high risk factor.

By definition, a startup is new, has no objective market value, and is much more likely to fail than to succeed. This is why it is usually very difficult for startups to obtain seed money through traditional loans. For this reason, startups and investors need creative solutions to fund early business development. One such creative solution is the Simple Future Equity (SAFE) contract.

What is a CHEST?

A SAFE is a creative financing arrangement that allows investors to provide seed funding to the business. However, instead of a loan that promises the noteholder that they will be repaid the principal of the loan plus interest, SAFEs generally allow the noteholder to convert their funding into shares (or the right to buy them) in the startup at a preferential and reduced rate. .

How does a safe work?

As discussed in the section above, SAFEs provide equity or the ability to buy equity at a steep discount in a startup in exchange for seed investment in the startup. In a perfect world, the startup will thrive and the startup investor’s contribution will result in a stock value several hundred times greater than the initial investment.

Although SAFEs are similar to convertible notes, they differ in several respects. First of all, SAFEs are not loans. For this reason, the SAFE Notes are not listed as debt on the startup’s books. This distinction is important because if the startup goes public or gets its first valuations to invest, the value of the startup will be negatively affected by the debt on its books.

A SAFE has no set expiration or maturity date, which provides both the holder and the startup with an additional element of flexibility. For example, if the startup is close to a second round of funding, but a maturity date on a convertible note is hanging over its head, new investors might be scared off. However, since SAFEs are not loans, there is no debt or repayment date. Yet the equity conversion aspect of SAFEs means that the noteholder’s stock options are protected anyway.

In addition, convertible notes usually come with interest rates. Even though this interest is usually converted into additional shares, it is still additional debt for the startup, and startups are always better off with less debt on their books.

Another important part of SAFEs is that they do not have an eligible fundraising amount. This means that SAFE holders can exercise their share rights automatically when the startup receives additional funding. Convertible notes, on the other hand, often contain qualifying equity clauses.

SAFEs also do not have deferred valuation clauses. Deferred valuation clauses allow the issuer of a SAFE to defer to a later date the holder’s right to purchase shares if the startup does not reach a certain valuation, a clause often found in convertible bonds. Although the clause does not necessarily harm the noteholder, it could prevent him from exercising his share rights and liquidating or transferring them if the need arose.

At the end of the day, SAFEs essentially operate like a purchase of phantom shares. In exchange for early startup funding, SAFE holders essentially become shareholders of the startups they buy tickets from. When, where and if the SAFE holder exercises their stock options under the SAFE rating is clearly and concisely stated in the terms of the SAFE.

Why would investors choose a vault?

While both SAFEs and convertible notes are creative ways for investors to provide seed funding, SAFEs offer noteholders significant advantages over convertible notes. The first of these advantages is simplicity.

Convertible notes can be complex and contain a number of different trigger clauses that must be met before the note holder becomes a shareholder in the startup. For this reason, the mere act of negotiating a convertible note between the issuer and the noteholder can require an enormous amount of negotiation between the parties.

Usually, the negotiation leads to lengthy legal reviews of each convertible note proposal. These legal fees are essentially dead money for the issuer of the convertible note and the holder of the note. It’s money that has to be paid, but money that neither of them can really get back.

In contrast, SAFEs are simpler, with no maturity dates, discount rates, interest rates, or valuation cap discounts, because SAFE Notes offer simple equity in exchange for funding. So SAFE holders may be more likely than convertible note holders to have their money turned into equity, and they get a simple, easy-to-understand document that outlines exactly how that conversion takes place.

Like convertible notes, SAFEs are unsecured and involve a lot of risk. As the SEC guidance points out, “despite the identified triggers for SAFE conversion, there may be scenarios where the triggers are not activated and the SAFE is not converted, leaving you with nothing. For example, if a company you have invested in makes enough money to never need to raise capital again and it is not acquired by another company, the SAFE conversion may never be triggered.

SAFEs generally contain low valuation caps that allow them to convert their rating into shares at a lower price than future shareholders. For these reasons, many start-up investors prefer SAFEs to convertible notes.

Benzinga’s best starter deals

A few successful seed investments can boost your investment portfolio and create almost unimaginable wealth compared to the initial investment amount. Although startups can be a little too risky to build your entire portfolio around, they are great ways to diversify while adding upside potential. If you’re looking for startups to invest in, take a look at Benzinga’s top startup deals below.

Minimum investment: $100 – $999

Investment term: N/A

Open to non-accredited investors? : Yes

Minimum investment: < $100
Investment term: N/A

Open to non-accredited investors? : Yes

Should you buy safes?

Investing in startups remains an excellent way to simultaneously accomplish the two missions of wealth building and diversification. One of the best ways to invest in startups is to buy SAFEs. They’re relatively simple investment vehicles that give you a great opportunity to get equity in exciting startups at a price well below what you’ll pay after an initial public offering.

You should therefore consider incorporating SAFEs into your investment portfolio. As with all investments, you should consider your goals and risk tolerance before buying a SAFE. But if you’ve done your due diligence and like what you see, the right SAFE could pay huge dividends down the road. If you have any questions about SAFE or seed funding in the meantime, Benzinga will be there as a resource to provide valuable information.

FAQs

What is seed funding and how does it work?

1

What is seed funding and how does it work?

request

Eric McConnell

1

Imagine a start-up as an apple seed. It can become a profitable business, but it needs water. In the world of startup investing, seed funding is like water. Farmers provide water and positive conditions for seeds to grow into fruit trees, while investors invest in a startup in the hope that it will grow into a profit-generating business. The money that investors provide to startups is known as “seed funding”.

If the farmer’s seed becomes a fruit tree, the farmer profits from the sale of the fruit. Similarly, investors who provide seed funding to startups usually get an equity stake in the startup if it becomes profitable. The amount of equity is usually predetermined by a convertible note or a SAFE note which is negotiated between the startup and the investor.

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