SAFE - Pro rata side letter (U.S. Companies)

Under the technological era, the start-up ecosystem has emerged as advancements in technology have made it easier for individuals to pursue their dreams. To all startups, early-stage funding is critical, and a simple agreement for future equity (SAFE) has started to gain popularity, being a short and flexible agreement providing future equity rights.

In SAFEs, startups may receive funding from investors without determining a valuation or issuing equity immediately. Their investments will be converted into equity once a predefined triggering event occurs (such as an equity financing round or liquidity event). SAFEs are different from traditional financing methods such that they do not accrue interest or have a maturity date.

A SAFE (Simple Agreement for Future Equity) with a pro rata side agreement further allows investors to maintain their ownership percentage during future financing rounds by giving them the right to purchase additional shares. Below is an outline of a SAFE that includes a pro rata side agreement.

Pro Rata Right provides that the investor shall have the right to purchase additional shares in any future financing rounds to maintain their proportional ownership in the Company. The Company agrees to notify the investor of any such financing, including details on the number of shares offered and the terms.

Upon the operation of the Pro Rata Rights, the Company will provide the investor with written notice of any proposed financing within certain days prior to the closing of such financing. And the investor must exercise their pro rata rights within certain days of receiving the notice from the Company.

For startups, SAFEs with pro rata side letter is an important tool for investors to protect their ownership stakes in a company as it grows and raises additional capital. Both companies and investors should consider the implications of these rights when negotiating investment agreements. It can avoid the significant equity dilution for founders, allowing them to keep more control over the company. Also, since SAFE is not a debt instrument and does not accrue interest, it avoids the pressure of accumulating debt and making repayments. As for investors, the major attraction of a SAFE is the potential for high returns, since their equity could appreciate substantially once the startup succeeds.

 

How to use this document?

To use the 'Pro Rata Agreement' document, follow these steps:

1. Familiarize yourself with the document: Read through the entire document to understand its purpose, terms, and conditions.

2. Identify the parties involved: Determine the names and addresses of the contracting parties, referred to as 'Party 1' and 'Party 2' in the document.

3. Consider pro rata rights: discuss and execute a pro rata rights agreement with the company.

4. Prepare for the Written Notice to the Investors: Familiarize yourself with the provisions related to Equity Financing in Section 1. Understand the obligations of the company to notify the investors about any proposed financing. 

5. Prepare for the execution of the Pro Rata rights by the Investors: Familiarize yourself with the provisions related to Equity Financing in Section 1. Understand the rights of the investors to exercise the Pro Rata Rights upon being notified of any proposed financing by the Company.

6. Monitor termination conditions: Be aware of the conditions under which the agreement will   automatically terminate, as outlined in Section 1.

7. Seek legal advice if necessary: If you have any questions or concerns about the document or its implications, consult with a legal professional to ensure you fully understand your rights and obligations.

By following these steps, you can effectively use the 'Pro Rata Agreement' document and navigate the process of issuing shares to the investor.