Not So Simple, After All
While Silicon Valley is known for innovation in the tech space, another important component of the startup world is raising capital to get ideas off the ground. With that in mind, one of the tools that has been developed and popularized in recent years is the Simple Agreement for Future Equity, or “SAFE” Agreement.
Developed and advertised as a simple and flexible tool for raising capital in the early stages of a business, SAFE Agreements were designed to allow companies to offer prospective investors the ability to “get in early”, while concurrently allowing the company to raise funds without the costs and complications associated with a more traditional capital raise. Popularized in the United States, the use of SAFE Agreements is growing worldwide, including here in Canada.
Despite the intention of providing a simple investment vehicle, there are numerous legal and practical considerations which go into a SAFE Agreement, and some of these considerations are perhaps even more relevant as these instruments are adapted to comply with Canadian laws.
What is a SAFE Agreement?
Despite a push for standardization, there is no single or “standard” SAFE Agreement. Perhaps the key defining feature of a SAFE Agreement is the lack of a predetermined “price” per share or unit. Rather than agreeing on a price per share up front, the investor and the company generally instead agree that the investment will “convert” into shares or units of a company upon the occurrence of certain future “triggering” events.
While triggering events can vary, they generally revolve around the occurrence of a future liquidity event, such as a more traditional capital raise or the purchase and sale of the company to a larger investor. The idea behind a SAFE Agreement is that SAFE investors generally negotiate a “discount” or valuation cap such that, on the occurrence of the future liquidity event, the SAFE investors will have their investment convert to shares at a lower or “discounted” price than the price being offered to investors at the time of the liquidity event. This discount is the premium SAFE investors get for providing early-stage capital.
SAFE Agreements will generally further address what happens to the investors on other triggering events, such as the dissolution of the company or a listing on a public stock exchange.
Why use a SAFE Agreement?
The general idea behind using a SAFE Agreement is that it is supposed to be a simpler and more flexible tool than a traditional sale of shares or options. It also aims to be simpler than a convertible debt financing, and there is generally on obligation to repay or issue shares to the SAFE investors until the occurrence of the future triggering events. As a result, the legal and accounting costs associated with a SAFE Agreement raise are often less than those incurred in a traditional financing or capital raise.
In addition to the cost savings, SAFE Agreements can be helpful for early-stage businesses where they have not yet determined a valuation, as the SAFE Agreement often postpones the valuation until a later date when a more fulsome capital raise can take place (at which time the business may be further along and more readily valued).
Finally, SAFE Agreements allow companies to raise capital on a “rolling” basis. In most traditional financings, the “round” of financing will close when the company hits pre-determined targets. Until that time, invested funds are generally held in escrow. With a SAFE Agreement, while it can be done in “rounds”, there is generally more flexibility to sell the investment and use the proceeds immediately.
What are the Concerns?
While they are advertised as being simple, negotiating and agreeing on the triggering events for a SAFE Agreement and what occurs on each can be more complicated than it may initially appear. If valuation caps are used, companies can also end up giving away more future equity than they intended. In addition, Canadian businesses need to be cognizant of the rules around selling securities in Canada, and issuing SAFE investments without proper consideration can easily leave a company offside the applicable laws.
From an investor’s perspective, it is important to keep in mind that the “triggering events” in the SAFE Agreement may never occur, in which case the investor is often left with little recourse. In addition, investors should keep in mind that, prior to a conversion happening on a triggering event, they are not shareholders in the company and will not have voting or dividend rights. Further, unless otherwise provided for in the SAFE Agreement, investors may be limited in the amount of information they receive regarding the company. Finally, if a company goes out of business, SAFE investors may be left with nothing to show for their investment.
In conclusion, SAFE Agreements while useful in the right circumstances, come with numerous considerations both from the issuer and investor perspective that are best addressed using professional advice. If you are a business considering raising capital through a SAFE Agreement or an investor considering making an investment through a SAFE Agreement, please contact Joshua N.C. Ungar to discuss your options and key considerations.
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