The Y Combinator (YC) SAFE agreement has become the dominant instrument for early-stage startup funding, now used in 88% of pre-seed and seed financings according to Carta. While the SAFE is lauded for its founder-friendly terms and simplicity, it presents several challenges for investors—especially when a traditional priced round never materializes.
The Problem with Standard SAFEs
- No Priced Round, No Upside: If a startup raises money via a SAFE but never completes a priced equity round (like Series A Preferred Stock) and instead becomes self-sustaining, SAFE holders may be left with only their original investment returned in the event of an exit, with no participation in the upside.
- QSBS Tax Treatment Uncertainty: The IRS has yet to issue definitive guidance on whether SAFEs qualify as "pseudo equity" for the purposes of Qualified Small Business Stock (QSBS) tax treatment. This matters because, under IRC §1202 and the enhancements from the One Big Beautiful Bill Act (OBBBA) of July 4, 2025, investors can realize tax-free capital gains on up to $15M or 10x their investment—if their instrument qualifies.
Enhancing SAFEs for Investors and Founders
SAFEs are not set in stone. Like convertible notes, their terms can be customized. One powerful modification is adding an optional conversion to Common Stock at a predetermined post-money valuation, triggered by a majority vote of SAFE holders if a priced round does not occur within a set timeframe.
Why This Matters
- QSBS Eligibility: Optional conversion features can strengthen the argument that a SAFE is equity-like, potentially qualifying for QSBS benefits.
- Cap Table Clarity: With a fixed conversion price, companies can reflect SAFE investments on their fully-diluted cap tables together with stock options and warrants, improving transparency for both founders and investors. (Should a priced round occur these shares would be moved from the Common Stock column to the Series A1 Preferred Stock column on the cap table, at the discounted share price or the valuation-capped share price, whichever turns out to be better for the investors.)
- Investor Protection: In the event of a sale or IPO without a priced round, SAFE holders can convert to Common Stock and participate in the upside, rather than being limited to a return of their principal.
The Venture Mechanics (VM) SAFE: A New Approach
Venture Mechanics has published a new SAFE template that addresses these shortcomings while maintaining founder-friendly flexibility. Building on the original "YC hybrid" SAFE—which offered both a discount to a future round and a valuation cap—the VM SAFE introduces several key enhancements:
Key Features of the VM SAFE
- Hybrid Terms Restored: Unlike the latest YC SAFE (YC4), which forces founders to choose between a discount or a valuation cap, the VM SAFE allows both, giving investors the better of the two.
- Optional Conversion to Common Stock: After three years, or any time before a qualifying equity or liquidity event, SAFE holders (by majority vote) can convert their investment to Common Stock at the valuation cap price.
- Cap Table Inclusion: This structure allows SAFEs to be included on the cap table as as-converted Common Stock, increasing the likelihood that the IRS will deem the QSBS holding period to start at investment, not conversion.
- Founder-Friendly by Extension: By making the SAFE more attractive to investors, startups can more easily raise capital, and founders themselves can benefit from the same QSBS tax advantages.
Multiple Benefits
- Upside Participation: Investors are no longer limited to a 1x return if no priced round occurs—they can fully participate in exit upside.
- QSBS Positioning: The structure supports a stronger case for QSBS qualification, though ultimate IRS determination is still pending.
- Flexible for Founders: Founders can still opt to remove the discount if they prefer a cap-only structure, but offering both terms can attract more investor interest.
See our related articles on Why SAFE Notes Are So Rapidly Overtaking Convertible Notes as the Structure of Choice for Pre-priced Rounds and How Changes to QSBS (Section 1202) in the OBBBA Further Incentivize Investing in Startups.
Download the new VM SAFE Term Sheet and investment documents to see these investor- and founder-friendly features in action.
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