iSAFE India: A Comprehensive Guide for Startups and Investors

The Indian startup ecosystem is booming, and with it comes the need for innovative funding solutions.  One such solution gaining traction is the India Simple Agreement for Future Equity (iSAFE). But what exactly is iSAFE, and how does it work?  This article dives into the world of iSAFE, explaining its purpose, benefits, and how it differs from traditional funding methods.

What is iSAFE?

The "India Simple Agreement for Future Equity" (iSAFE) is a variant of the well-known Simple Agreement for Future Equity (SAFE) instrument, tailored for use in India. Similar to the original SAFE, the iSAFE is a financial instrument used by startups to raise early-stage funding. It allows investors to invest in a startup in exchange for the right to receive equity in the company at a later date, typically upon the occurrence of a future financing round or a specific milestone.

The iSAFE is designed to be a simpler and more founder-friendly alternative to traditional equity financing. It does not involve the immediate issuance of shares or the valuation of the company at the time of investment, which can be complex and time-consuming in early-stage startups. Besides this, iSAFE, a comprehensive 5-6 pager agreement, eliminates the requirement of entering into extensive Shareholder agreements (SHAs) with investors which can often be an unwieldy process for early-stage startups, involving not just time and money but also the hassle of engaging legal counsel. Instead, the investor receives a promise (or agreement) from the company that, upon the occurrence of certain trigger events, they will receive a predetermined number of shares in the company.

This instrument is particularly popular in the startup ecosystem as it allows startups to raise capital without having to determine a valuation early on, which can be challenging for early-stage companies with limited operating history and revenue. Additionally, it provides investors with a relatively low-risk way to invest in startups, as they only receive equity if the startup achieves certain milestones or raises additional funding, mitigating some of the risks associated with early-stage investing.

The iSAFE has gained popularity in India due to its flexibility and simplicity, making it an attractive option for both startups and investors looking to participate in the Indian startup ecosystem.

Origin of term iSAFE

The Simple Agreement for Future Equity (SAFE) was created by Y Combinator, a prominent startup accelerator based in Silicon Valley. It was introduced in 2013 as an alternative to traditional convertible notes, which were commonly used for early-stage startup funding but were often considered complex and difficult to understand.

The SAFE was designed to be a simpler and more founder-friendly instrument for raising early-stage funding. Unlike convertible notes, which have debt-like characteristics and accrue interest, the SAFE is a form of equity financing. However, unlike traditional equity financing, which involves the immediate issuance of shares and valuation of the company, the SAFE defers the issuance of shares and the determination of valuation until a future equity financing round or other triggering event.

The SAFE has since become a widely used instrument in the startup ecosystem, particularly for early-stage funding rounds. It is favored by both startups and investors for its simplicity, flexibility, and founder-friendly terms.

The concept of India Simple Agreement for Future Equity (iSAFE) is derived from the United States' Simple Agreement for Future Equity (SAFE). However, iSAFE isn't a direct copy. It's an adaptation designed to comply with India's existing legal framework.

Here's a breakdown of the origin:

• US SAFE: Created by Y Combinator, a startup incubator in the US, in late 2013. It offered a simpler alternative to convertible debt for early-stage funding.
• iSAFE in India: Introduced by 100X.VC, an early-stage investment firm in India. The exact year isn't universally documented, but it likely emerged in the mid-2010s as the Indian startup ecosystem matured and the need for such instruments grew.

Key Differences between US SAFE and Indian iSAFE:

• Legal Basis: A US SAFE is a contract, while an iSAFE utilizes Convertible Compulsorily Convertible Preference Shares (CCPS) as defined under the Companies Act, 2013 of India.
• Pre-money and Post-money Valuation: Not required for issuing iSAFE, unlike US SAFE which often involves determining the company's valuation before or after the investment.
• Debt vs. Equity: A US SAFE can be structured as debt or equity, while iSAFE is generally considered convertible equity.

Overall, iSAFE offers a valuable tool for startups in India to secure funding without the complexities of traditional venture capital agreements. It reflects the adaptation of a global concept to suit the specific legal and financial environment of India.

Is iSAFE is legal in India?

There's no specific law in India governing convertible instruments like iSAFE. However, it's considered a legal and commonly used method for startup funding due to the following:

• Structured as Compulsorily Convertible Preference Shares (CCPS): iSAFE agreements are designed to function similarly to CCPS, a legal concept recognized under the Companies Act, 2013 of India (specifically Sections 42, 55, and 62).
• Regulated by Existing Laws: Since iSAFE operates as a type of CCPS, it falls under the regulatory framework governing these shares. This ensures legal validity and clarity for both investors and startups.

How Does iSAFE Work?

Here's a simplified method of the iSAFE process:

• Agreement Signing: The startup and investor sign an iSAFE agreement outlining the investment amount, conversion triggers (events that cause conversion to equity), and discount rate (potential price reduction for early investment).
• Investor Provides Funds: The investor provides the startup with the agreed-upon investment amount.
• Conversion Trigger: Upon a pre-defined event (e.g., a new funding round), the iSAFE note converts into equity shares at the company's valuation at that time, considering the discount rate

Here's a breakdown of the legal aspects:

• Legality: iSAFE agreements are generally considered legal in India due to their structure as CCPS.
• Benefits of CCPS Structure: Using CCPS offers advantages like:

• Legal recognition and enforceability of the agreement.
• Clarity on conversion rights and triggers for investors.
• Visibility of the investment on the company's cap table (record of ownership interests).

Important Considerations:

• Drafting the Agreement: A well-drafted iSAFE agreement is crucial to ensure clarity and avoid legal disputes. Consulting a advisor with expertise in startup funding is recommended.
• Taxation: While there are no specific regulations for iSAFE taxation yet, it's generally treated similarly to CCPS. Consulting a tax professional is advisable to understand the potential tax implications.

Overall, iSAFE is a legitimate and popular method for startup funding in India. Its basis in CCPS provides a legal framework, but proper agreement drafting and tax considerations are essential.

iSAFE vs CCPS in India: Choosing the Right Option for Your Startup

iSAFE and CCPS (Compulsorily Convertible Preference Shares) are both used for startup funding in India, but they have some key differences. Below are the key difference between them:

Function:

• iSAFE: An agreement for future issuance of equity (CCPS) at a predetermined valuation or upon the occurrence of a specific event (like a valuation round, merger, dissolution). It acts as a convertible note with some unique features.
• CCPS: A class of preference shares defined under the Companies Act, 2013. These shares convert into regular equity shares.

Legality:

• iSAFE: Not a specific legal instrument but utilizes the existing framework for CCPS.
• CCPS: A recognized legal class of shares under the Companies Act, 2013.

Valuation:

• iSAFE: Doesn't require pre-money or post-money valuation at the time of issuing the iSAFE. Valuation typically occurs when the note converts to equity.
• CCPS: May require a third-party valuation before issuing the CCPS, although this isn't always mandatory.

Conversion Trigger:

• iSAFE: Conversion can be triggered by events like a priced funding round, acquisition/merger, or a predetermined date.
• CCPS: Conversion is typically triggered by a liquidity event or upon reaching a specific financial milestone as defined in the company's at the time of issue.

In essence:

• iSAFE: A simpler agreement designed for early-stage funding, offering flexibility regarding valuation and conversion triggers.
• CCPS: A more formal class of shares with a defined legal framework, potentially offering some additional rights to the investor.

iSAFE as an agreement for future shares, while CCPS are the actual shares themselves with predetermined conversion terms.

This article provides a basic understanding of iSAFE. Remember, startup funding can be complex. It's advisable to conduct further research and seek professional guidance to make informed decisions for your startup journey.