Traditionally, investments in start-ups and early stage companies have been made using either ordinary or preference equity, or using debt that is convertible into equity. These types of investment can be complex and are usually costly and time-consuming to implement, especially relative to the investment size. For some time, both investors and investee companies have been looking for more straightforward ways to do deals, especially for investments in very early stage businesses. In recent times, we have seen more and more proposals to do early stage investments using a “SAFE” or “simple agreement for future equity”, to give it its full name. In this article, Andrew Windybank, Principal of our corporate and commercial group, considers the benefits of early stage investments using a “SAFE” or “simple agreement for future equity”.
At its simplest, a SAFE involves an investor (“Investor”) paying an amount (“Purchase Amount”) to an investee (“Company”) in return for a promise by the Company to issue shares to the Investor in the future (“SAFE Shares”). Typically, the issue of the SAFE Shares would be triggered by the occurrence of one of certain specified events, such as a capital raising or initial public offering or, in some cases, on a specified maturity date if it occurs earlier. The SAFE will include a mechanism for calculating how many SAFE Shares are to be issued and there are many variations on this theme. In addition to capital raising and IPO type exits, it is typical for a SAFE to provide for SAFE Shares to be issued to the Investor in the event of a share or trade sale, or for the Investor to be paid an amount equal to the Purchase Amount. The trigger events and how they are described are very important, especially if a SAFE does not have a maturity date, as typically the Company will only be required to issue SAFE Shares (or make a payment) to the Investor if one of the events occurs.
Although the Investor pays the Purchase Amount and is not issued with SAFE Shares until a later point in time, the Purchase Amount is not a debt. Accordingly, a SAFE does not provide for the payment of interest or for repayment. SAFEs originated in the USA and the U.S. Securities and Exchange Commission considers a SAFE to constitute a “security” under United States law. Whilst ASIC has not yet released any guidance in relation to SAFEs, a SAFE would generally appear to fall within the definition of “security” for the purposes of section 761A of the Corporations Act 2001 (Cth) (“Act”). As a result, companies that wish to offer a SAFE should ensure compliance with or exemption from the fundraising provisions of the Act. A SAFE is not a share however and a SAFE holder will generally not be entitled to receive dividends or to exercise voting rights until SAFE Shares are issued. A SAFE will tend to be an illiquid investment as the SAFE Share may only be transferred once issued and most SAFEs themselves are not freely assignable.
As would be expected, one of the aspects of a SAFE that involves the most discussion is the mechanism for determining how many SAFE Shares the Company must issue. For capital raisings and IPOs, the number of SAFE Shares is usually determined by dividing the Purchase Amount by the offer price per share. Other mechanisms may provide that SAFE Shares are to be issued at a discount to the offer price. Share and trade sale exits usually apply a per share value derived from the transaction valuation. More complex mechanisms may apply valuation caps and/or floors to the calculations, so that the number of SAFE Shares may be calculated using a different valuation to the trigger event transaction valuation.
An Investor may seek to include a “most favoured nation clause” in a SAFE. As would be expected, the object of such a clause is to give the Investor the right to benefit from any later more favourable investment terms agreed to by the Company. If the Company does enter into more than one SAFE, the Company should so far as possible ensure that the SAFE documents are on common terms, as this will make administration easier.
Given failure is a very distinct possibility in start-ups and early stage businesses, most SAFEs will provide a liquidation preference for the Investor. Essentially this will provide for the Investor to be paid an amount equal to the Purchase Amount before any funds are distributed to shareholders in the event of a winding up. If there are multiple SAFEs in place and the Company has insufficient funds on liquidation to pay all SAFE investors in full, a SAFE will usually provide for each SAFE investor to receive a pro-rated payment in proportion to the respective purchase amounts.
A SAFE will not be suitable in all investment scenarios. Where a SAFE is proposed to be used, each party should consider in detail whether a SAFE will meet its desired investment objectives and risk profile. A SAFE may be appropriate where an investor does not want or need to have significant control over the investee and does not require liquidity or to receive income (e.g. interest or dividends). SAFEs are not generally suitable for investments in more mature businesses or where an investor wants to exercise a significant level of control over the investee company. In particular, investors who are not professional or sophisticated investors should exercise caution when considering an investment by way of a SAFE.
This article is not legal advice. It is intended to provide commentary and general information only. Access to this article does not entitle you to rely on it as legal advice. You should obtain formal legal advice specific to your own situation. Please contact us if you require advice on matters covered by this article.