Earlier this month, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin entitled “Investor Bulletin: Be Cautious of SAFEs in Crowdfunding.” The bulletin was meant to warn and educate retail investors – an individual investor who buys and sells securities for their personal account – about the dangers of investing in startups through a Simple Agreement for Future Equity (SAFE).
What Are SAFEs?
An alternative to convertible debt, a 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 trigger events occur. Developed as a way for venture capital investors to quickly invest in startups, SAFEs were designed to be faster to generate than convertible notes with lower costs. The agreements have started to gain traction recently, particularly on the West Coast, including in Silicon Valley.
Speaking at an annual SEC/NASAA conference on May 9, Commissioner Michael S. Piwowar expressed concern about the use of SAFEs with retail investors in Regulation Crowdfunding. In contrast to sophisticated venture capital investors, SAFEs are “not securities with which many retail investors are well acquainted,” Piwowar said. He went on to say: “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.”
Piwowar’s remarks, which echo previous comments from the SEC, came the same day the Office of Investor Education and Advocacy released its investor bulletin. In it, the office emphasized that SAFEs are not common stock and the investor is not getting an equity stake in return. “There is nothing standard or simple about a SAFE,” it wrote. “Various terms from the triggering events to the conversion price are subject to different treatment by different companies offering SAFEs.”
Piwowar and others urging investors to tread carefully with SAFEs have cited an academic paper published in late 2016 by Virginia Law Review Online, which surmised that early market participants “are potentially sabotaging the crowdfunding experiment” by making widespread use of SAFEs, which “may frustrate the ability of investors to share in the upside of successful crowdfunding companies.”
From a company perspective, SAFEs are amazing because they have all the advantages of convertible notes (lower transaction costs, no fiduciary duties owed to the investors and the parties don’t have to negotiate valuation of the company – though there is often a discussion about a cap on that valuation) and they have none of the disadvantages (no interest accrues and there is no maturity date). But, from an investor standpoint, those are issues create additional risk.