Understanding Security Types in Equity Crowdfunding
As equity crowdfunding has matured, the need for new security types has become apparent in recent years. To meet this need, the equity crowdfunding industry has turned to modifying existing security types to make them more friendly to equity crowdfunding. As a savvy investor, it’s important to understand these new security types and how they work.
Recently, we went over the crowd note, a version of the convertible note that was created specifically for equity crowdfunding. Another security type that you may encounter in equity crowdfunding is the SAFE.
What are SAFEs?
A Simple Agreement of Future Equity, or SAFE, is an agreement that promises the potential for a future equity stake based on the amount invested on the condition that a triggering event occurs. A triggering event could be anything from an additional round of funding to the acquisition of the company. Unlike a convertible note or a crowd note, however, a SAFE is not a debt obligation.
Benefits of the Crowd SAFE
In the early days of equity crowdfunding, a common issue startups experienced with issuing traditional equity securities was that they left them with many unaccredited investors on their cap table. This could be problematic for a variety of reasons:
- Crowded cap tables can potentially deter future investment from traditional institutions.
- Reporting to hundreds of shareholders can “gum up the works,” so to speak, as startups try to provide information to which shareholders are generally entitled.
- Under U.S. securities regulations, a company with $10 million in assets and 500 unaccredited shareholders must go public.
For startups, the crowd SAFE provides more flexibility than other security types. Notable features of the crowd SAFE are that they may be extended, they have a fixed conversion price, and that they limit investor rights.
The terms of the crowd SAFE are customizable to the needs of the startup and can be used by both early- and late-stage companies before, alongside, or after another equity issuance.
Things to Keep in Mind about SAFE Securities
They are not common stock
When investing in a SAFE, you are an investor, but you are not an actual stock shareholder. (Unless the company converts the SAFE into stock). In order for you to receive any shares in the company, the terms of the SAFE must first be met through the triggering event.
Conversion to equity only happens if triggering events occur
The triggering event could be a merger or acquisition, additional funding, or an initial public offering. As an investor, you should know the terms of the SAFE
A SAFE conversion may never be triggered
Depending on the terms of the SAFE, there is the possibility that the conversion event is never triggered. If the triggering event doesn’t happen, you could lose your entire investment.
Assessing Other SAFE Provisions
Aside from understanding the terms of triggering event, other pieces of the SAFE you should familiarize yourself with are:
- Voting rights: Again, SAFEs are not current equity stakes in a company; therefore, they do not offer the same voting rights you would get with common stock. Some companies may include terms that allow you to voice your opinion in certain situations, as they pertain to your SAFE.
- Conversion terms: These are the terms by which your investment converts to equity. Something to note here would be whether the SAFE converts just your original investment, or if it provides value over time.
- Repurchase rights: There could be a provision that lets the company repurchase your future right to equity, rather than converting into equity. If so, do the terms give you any say on the matter and the price at which your right is repurchased?
- Dissolution rights: If your investment is dissolved, you should know what happens to your SAFE.
Most importantly, you should know that there is no such thing as a “standard” SAFE note. As the terms are customizable, they will vary from company to company. This means that it’s critical you do your own due diligence to fully understand the company’s disclosure on the SAFE they’re offering as wells as the terms they outline in the agreement before making an investment.