The Safe (simple agreement for future equity) was introduced by Y Combinator in 2013, and are now a widely adopted financing instrument for early-stage startups (and a typical way to finance “pre-Seed” stage companies).
Safes are standardized agreements (that are similar to warrants or options) for equity in a business that enable investment into a company without a defined purchase price to be determined at a later date and set by certain conditions.
Safes are a form of convertible instrument which acts as a standardized non-debt payment for deferred purchase of preferred stock to a priced round at an equal to or lower price determined by components dictating conversion mechanics.
The Safe was revised in 2018 to better reflect how the instrument was used in practice (where instead of investment as a direct precursor bridging a later priced round, safe investments were used towards early rounds on their own without an intent to value the company in the near term).
Safes are triggered by the purchase of equity in a round where there is a defined purchase price and the purchase price of shares for safe holders is defined in relation to that purchase price. How the price of a safe compares to the price in a priced round is defined by the financial terms associated with the safe.
A valuation cap places a cap on the valuation of the business at a certain capitalization. For the post-money (current, since 2018) safe, the valuation cap is the value of the business that includes:
The valuation cap divided by the total number of shares in that capitalization is what determines the share price for the safe holder.
A discount (which is often expressed as 1 - discount through a “discount rate”) is another way of determining share price for convertible instruments when they convert with the price of those instruments being discounted relative to the price of shares in a priced round.