The Securities and Exchange Commission (SEC) is keeping a close eye on the developing equity crowdfunding industry. The agency recently issued an Investor Bulletin regarding the risks associated with Simple Agreements for Future Equity (SAFE) crowdfunding securities, which are increasingly being used in equity crowdfunding campaigns.
What Are SAFE Securities?
A simple agreement for future equity, or “SAFE,” is an agreement between an investor and a company in which the company generally promises to give the investor a future equity stake in the company if certain triggering events occur. The origin of this unique securities offering can be traced to Silicon Valley, where startup accelerator Y Combinator used it to invest in startups that expected to raise institutional venture capital at a later date.
As described in a 2016 Virginia Law Review Online article, the SAFE closely resembles a classic seed-stage convertible note. However, there are several distinct differences that make it riskier for investors. Most notably, there is no maturity date, the security does not accrue interest while it remains outstanding, and it does not pay dividends. The SAFE holder is also not entitled to vote on issues put before shareholders. “The SAFE is, in essence, a contractual derivative instrument that amounts to a deferred equity investment. It will prove valuable to the holder if, and only if, the company that issues it raises a subsequent round of financing, is sold or goes public,” the authors explain.
Risks of SAFEs for Crowdfunding Investors
In its Investor Bulletin, the SEC warns that “[t]here is nothing standard or simple about a SAFE.” As the agency highlights, unlike common stock, SAFEs do not represent a current equity stake in the company in which you are investing. Rather, a SAFE provides investors with a future equity stake based on the amount invested only when a specified triggering event occurs. Examples include if the company is acquired by or merges with another company, conducts another round of equity financing, or pursues an initial public offering of securities.
In some cases, the triggering event may never occur, and the investment becomes worthless. As the SEC explains, “if a company in which you invested makes enough money that it never again needs to raise capital, and it is not acquired by another company, then the conversion of the SAFE may never be triggered.”
In recent remarks at the annual SEC/NASAA conference, SEC Commissioner Michael S. Piwowar also expressed concern about SAFEs. He stated:
In contrast to the sophisticated venture capital investors for whom SAFEs were originally intended, Regulation Crowdfunding is designed to serve as a new method of raising capital from a broad, mostly retail base of investors. Regulation Crowdfunding thus requires the intermediary facilitating the offering to provide investors with educational materials, including information about the types of securities offered and sold on the intermediary’s platform and the risks associated with each type of security. Intermediaries face a real challenge in educating potential investors about this high-risk, complex, and non-standard security when the security itself is entitled “SAFE.” Companies and their intermediaries should think carefully about how they name or describe their securities. Securities marketed as “safe” or “simple” ought to be just that.
For investors, the primary message is simple — do your due diligence. That means making sure that you fully understand the offering company’s disclosure regarding the SAFE as well as the terms set forth in the actual agreement.
If you have any questions regarding SAFE crowdfunding securities or if you would like to discuss the matter further, please contact me, Dan Brecher, 201-806-3364.