Saf Finance Test

The SAF (Simple Agreement for Future Equity) Finance Test is a method used to evaluate the potential financial viability and fairness of a SAFE (Simple Agreement for Future Equity) note investment in a startup company. It's not a formal, mathematically precise calculation, but rather a framework for investors to consider various factors that could impact their potential return on investment when the SAFE converts to equity.

The core principle behind the SAF Finance Test is to analyze how different valuation scenarios and conversion terms will affect the investor's ownership percentage in the future equity round. By running through different "what if" scenarios, investors can get a better understanding of the risks and rewards associated with a SAFE investment.

Here's a breakdown of the key considerations within the SAF Finance Test:

• Valuation Cap: This is a crucial element. It sets a maximum valuation at which the SAFE will convert to equity. A lower valuation cap is generally more favorable for the investor, as it allows them to receive more shares upon conversion, especially if the company later raises capital at a significantly higher valuation. Investors model different scenarios, such as the company raising at a valuation lower than, equal to, or higher than the valuation cap, to see how their ownership percentage changes.
• Discount Rate: A discount rate provides the SAFE holder with a discount on the price per share in the equity round. A higher discount is advantageous for the investor, offering more shares upon conversion. Similar to the valuation cap, different scenarios with varying equity round prices are evaluated.
• Minimum Investment Threshold (if any): Some SAFEs have a minimum investment threshold required to trigger conversion rights. The SAF Finance Test should ensure that the investor understands these thresholds and the implications if the threshold isn't met.
• Future Valuation Scenarios: The test involves estimating potential future valuations of the company at the equity financing round. This requires researching comparable companies, assessing the startup's market opportunity, evaluating the team's capabilities, and considering general market conditions. Conservative, moderate, and optimistic scenarios should be considered.
• Dilution: Investors must consider the potential for dilution. As the company raises additional rounds of funding, the ownership percentage of existing shareholders (including those who converted from SAFEs) will decrease. The SAF Finance Test helps estimate the impact of future dilution on the investor's ownership stake.
• Exit Scenarios: While more challenging to predict, thinking about potential exit scenarios (e.g., acquisition or IPO) and their implications for SAFE holders is part of the SAF Finance Test. If the company is acquired for a relatively small amount, the valuation cap and discount rate will heavily influence the investor's return.

By performing the SAF Finance Test, investors can answer questions like:

• What ownership percentage would I get if the company raises at a valuation equal to the valuation cap?
• What ownership percentage would I get if the company raises at a significantly higher valuation than the valuation cap?
• How much will my shares be worth if the company is acquired for X amount?

In conclusion, the SAF Finance Test is a crucial due diligence step for anyone considering investing in a startup using a SAFE agreement. While it involves estimations and projections, it provides a valuable framework for understanding the potential risks and rewards associated with the investment and for negotiating more favorable terms if possible. The ultimate goal is to make an informed decision about whether the investment aligns with the investor's risk tolerance and return expectations.