This article discusses the valuation of Simple Agreements for Future Equity (SAFEs) and convertible (promissory) notes.
Early-stage firms in the United States often raise capital using financial instruments that are different in some respects from the instruments commonly used by more established firms. While established firms may issue common stock, early-stage companies often rely on Simple Agreements for Future Equity (SAFEs) and convertible (promissory) notes. SAFEs and convertible notes are financing instruments that can convert into equity conditional upon some predetermined events, such as the issuing companies raising additional equity or being acquired. The conversion into equity is governed by the terms of the instrument, including any discount (the “conversion discount”) and/or cap (the “valuation cap”) relative to the price at which the company is raising financing or is being acquired. Even though SAFEs were used for the first time a little more than ten years ago, they have recently become a popular instrument for early-stage high-growth companies raising external funding for the first time.
While most early-stage companies eventually fail, there have been many instances of commercial disputes where a company’s valuation around the time that a convertible note or a SAFE was issued is of interest. However, the value of early-stage companies may not be reliably estimated through standard valuation techniques such as discounted cash flow or the method of comparables, leading to a need for alternative approaches to determine value.
This article discusses how the value of a company implied by the terms of a convertible note or a SAFE—and specifically implied by the terms of the valuation discount and/or the valuation cap—can be estimated, under certain assumptions, using standard methodologies in financial economics. While it is sometimes claimed that convertible notes and SAFEs allow the investors to “punt” on the question of how much the company is worth because they do not specify a fixed share price, this can be a misconception because, as discussed in this article, an implied valuation of an early-stage company can often be obtained from the contractual terms of these instruments.
This article was originally posted by Westlaw Today in January 2025.
Washington 
