SAFE Agreements: What They Mean for Investors & How They Could Work for Equity Crowdfunding
In 2013, Y Combinator introduced the simple agreement for future equity or SAFE agreement. The purpose of SAFE was to simplify the process of investing in startups for accredited investors, such as angels or small seed investment funds (as opposed to VCs, who invest using their own purchase- and investor-rights agreements). By and large it worked – the adoption was fast and many angel investors saw this as a great opportunity to speed up investing in companies.
Now, the question is: could SAFE agreements work for equity crowdfunding?
To understand SAFE, it’s helpful to see how its structure works for a company.
Let’s start with what it’s not: SAFE’s are neither debt nor equity, and they’re not on the balance sheet – instead they exist as a footnote on financial statements. Similarly, SAFE investors aren’t automatically on a company’s cap table when they invest, and they don’t become full-fledged investors until the SAFE converts.
What does this mean? A key element of a SAFE agreement is the conversion to equity trigger. Basically, a SAFE functions as a warrant or right to equity in a company, which is triggered by some future event like a minimum amount raised. For instance, say a company which issued a SAFE goes on to raise $1M in preferred or common shares in a subsequent funding round – that round could trigger the SAFE investment to convert into equity as well.
Unlike standard convertible notes, a SAFE usually has no end date or interest. This feature can be attractive for companies because it spares them the obligation to repay the investment at an arbitrary date if they’re not yet ready. SAFEs also typically offer discounts on the share price for the next funding round, whatever that price may be. That means the terms and valuation don’t have to be determined at the time the agreement is signed. The discount obviously benefits investors, as does eliminating back-and-forth on terms and valuation because, again, the whole idea is to speed up the process.
What’s good for accredited investors may not be good for the general public.
As I see it, to fit in the world of equity crowdfunding, the original SAFE agreement needs to be modified to protect retail investors. The main change is to include the securities offered upon conversion – both the type of security issued and its terms – in the SAFE agreement itself. Though this doesn’t need to be specified on a regular SAFE, it should be in the case of equity crowdfunding to offer greater transparency for everyday investors.
In my view, the other term that needs to change is the end date. As is, SAFE agreements can sit on a company’s books for years without allowing investors to receive shares. This doesn’t make sense for the general public, whose time horizon is often shorter than institutional investors and who may want to trade their shares on a secondary platform (regulation crowdfunding allows secondary trading after one year). We believe the solution here to protect consumers is to have the SAFE convert after two years, unless of course, the conversion to equity is triggered by a qualified investment or significant equity crowdfunding raise beforehand. This would help ensure liquidity – very important for everyday investors – while still providing companies substantial leeway while they get off the ground.
As equity crowdfunding grows, I feel we need to give entrepreneurs choices as to which securities to offer prospective investors. This makes it easier for them to raise the full stack of capital through the crowd. A company that previously offered SAFE to its investors should be able to continue offering SAFE with equity crowdfunding. Commons shares, preferred equity, convertible notes, and SAFE agreements all help founders structure the right capital raise for their businesses. And with customizations to meet the needs of the general public, we can provide these options on equity crowdfunding too.