To Stack Or Not to Stack?

Raising institutional capital has been challenging over the past several years, making SAFEs (Simple Agreements for Future Equity) even more popular in Canada. They are now used not only for pre-seed financing but also for multiple pre-seed rounds and bridge rounds between Seed and Series A rounds.

SAFEs are known for their simplicity and flexibility compared to traditional equity financing rounds, leading to the increased popularity of stacking SAFEs. The practice of stacking SAFEs involves raising capital through multiple SAFE rounds (and potentially on different terms) without converting any of them into equity until a priced equity financing round. This approach strategically allows startups to defer a valuation event, thereby potentially avoiding dilution at an early stage when the company’s valuation might still be low.

Stacking SAFEs at different cap rates can be an effective fundraising strategy, and we have observed several clients leverage multiple SAFE rounds in this manner. When done properly and equitably, stacking SAFEs can address some of the challenges faced when institutional capital is less accessible, offering a viable solution for raising funds.

There are several advantages to stacking SAFEs. SAFEs provide a quick and cost-effective way to obtain funding without the lengthy negotiations typical of traditional fundraising rounds. By deferring valuation, startups can benefit if they anticipate a significant increase in their future worth, allowing them to grow without diluting founder equity. Additionally, SAFEs, as their name suggests, are simpler and less complex than conventional convertible notes, which typically involve interest rates and maturity dates.

However, while SAFEs are designed to simplify fundraising for founders, stacking multiple SAFEs can lead to intricate conversion terms in the future. When different valuation caps and discounts are involved, converting these SAFEs into equity becomes a complex process. Managing the expectations of various investors during conversion can be challenging, and the cap table may become increasingly convoluted. Additionally, if founders are not diligent in tracking the different valuation caps, they risk significant over-dilution. We have observed startups that stack multiple SAFEs without considering the potential for excessive dilution, resulting in the unintended loss of control and equity.

When stacking SAFEs, there are some best practices startup founders should consider to simplify future financing rounds and reduce potential disputes. First, carefully evaluate the discounts and cap rates associated with each SAFE round. Investors prefer not to have significantly higher cap rates compared to their fellow investors within short periods. It is recommended to have at least 3-6 months between changes to the cap rate, ensuring these changes follow a period of growth or increased traction.

Additionally, some SAFE holders might request an MFN (most-favored nation) clause. This clause ensures that their investment terms will be adjusted to match any better terms offered in future SAFEs, thereby providing an added layer of security for their investment. However, MFN clauses can limit the startup's ability to negotiate specific terms with new investors or strategic partners who might bring unique value to the company.

We also recommend having a funding strategy in place before stacking SAFEs. A startup should clearly understand how the SAFE agreements will impact future financing rounds and company ownership. Consulting with financial advisors or lawyers will help navigate the complexities of stacking SAFEs and ensure that the terms align with the company’s long-term goals and vision.

While stacking SAFEs can provide a company with the necessary funding with fewer short-term complications, startups need to approach this strategy with an understanding of the long-term implications. At MT❯Ventures, we are happy to work with you as you navigate SAFEs and any other financing needs. Reach out to us if you need support on all things legal and SAFE.