A SAFE is an investment agreement between a company and an investor. The SAFE allows the company to receive capital while not distributing shares to the investor until a future date. It helps early-stage companies raise capital quickly without negotiating a clear valuation. That company valuation is not determined until a later round of funding.

As explained below, a SAFE can include a Valuation Cap, a Discount, or both. 

A valuation cap is the maximum value of the company that will be used to calculate the conversion of the SAFE investment into shares. This is used to provide the investor and the company with some sense of how much equity in the company will be transferred to the investor in the future, but it is done without setting a precise valuation on the company. 

Here are some examples of how a valuation cap works for early-stage investments. 

Example A: Conversion Above the Valuation Cap

In 2016, Blue Jeans Inc. raises $100,000 pursuant to a SAFE with Investor X.
The SAFE has a valuation cap of $1,000,000.  
Two years later, Blue Jeans Inc. agrees to raise $250,000 in funding from Venture Capital Group at a total company valuation of $5,000,000.

Pursuant to these terms: Investor X converts the SAFE investment at the valuation cap of $1,000,000. So Investor X receives 10% of the company's shares. 

Venture Capital Group will receive 5% of the company's shares for $250,000, as it has agreed to a higher valuation of $5,000,000.

Since Blue Jeans Inc. raised its second round above the valuation cap, Investor X benefits from their early investment by converting at a lower company valuation. 

​Example B: Conversion Below the Valuation Cap

In 2016, Blue Jeans Inc. raises $100,000 pursuant to a SAFE with Investor X.
The SAFE has a valuation cap of $1,000,000.  
Two years later, in 2018, Blue Jeans Inc. agrees to raise $250,000 in funding from Venture Capital Group at a total company valuation of $750,000.

Pursuant to these terms: Investor X converts the SAFE investment at $750,000 because the company has not raised money at or above the valuation cap. So Investor X receives 13.3% of the company's shares ($100,000 / $750,000). 

Venture Capital Group will receive 33.3% of the company's shares for $250,000, as it has agreed to a valuation of $750,000.

Since Blue Jeans Inc. raised its second round below the valuation cap, Investor X receives a higher portion of shares. However, Investor X won't happy with this outcome, as the overall value of the company is less than the valuation cap.

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A discount is a reduction in price the investor will receive when converting their investment into shares. Instead of setting a maximum value of the company through a Valuation Cap, a Discount gives a specific price advantage to early-stage investors. 

Example - SAFE with Discount

In 2016, Blue Jeans Inc. raises $100,000 pursuant to a SAFE with Investor X.
The SAFE has a discount of 20%.  
Two years later,  Blue Jeans Inc. agrees to raise $250,000 in funding from Venture Capital Group at a total company valuation of $5,000,000 for which it will receive 5% of the company's shares.

Due to the 20% discount, Investor X converts the SAFE at a company valuation of $4,000,000. So Investor X receives 2.5% of the company's shares for the $100,000 investment.
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A Most Favoured Nation clause is sometimes requested by investors to ensure that no investors participating in the same funding round receive better terms than what is contained in the SAFE. If the company offers preferential terms to another investor in the same round, the Most Favoured Nation clause imports those preferential terms into this agreement. 

Example - Most Favoured Nation 

Blue Jeans Inc. raises $100,000 pursuant to a SAFE with Investor X.
The SAFE has a valuation cap of $1,000,000 and a Most Favoured Nation clause.  
One month later, Blue Jeans Inc. raises another $100,000 pursuant to a SAFE with Angel Z. That SAFE has a valuation cap of $750,000.
Investor X's SAFE is then amended to a new valuation cap of $750,000 to match the terms given to Angel Z.