Simple Agreement for Future Equity (“SAFE”) notes and securities represent a potential conundrum for many issuers and investors. SAFE notes are in fact securities, as determined in the recent SEC Final Rule (Release No. 33-10884) and are eligible for trading and sale pursuant to the Regulation Crowdfunding (or “Regulation CF”) registration-exemption. But are SAFEs just the latest craze or is there something more here we all need to know about?
SAFE in Operation
We are attempting to peel back the onion and look at the SAFE construct in terms of what it means to both the issuer and the investor in terms of value, leverage, dilution, opportunity protection and control.
SAFE securities represent a future call on equity ownership in a given enterprise that amounts to a warrant to purchase securities or an option (essentially the same thing in the end) that is predicated upon the occurrence of a given event (the “trigger” or “trigger event”). If the trigger event happens, the holder of the SAFE becomes an equity security owner in the enterprise with all of the rights and powers that attend the other class members of the given security. So how does that really differ from a warrant?
Trigger vs. Investment Timing
It comes down to timing. The trigger is automatic, so the issue becomes the nature of the trigger event and that can be the weakness in the deal as far as an investor is concerned and as far as the issuer is concerned as well. Potential conflicts-of-interest may occur or the wrong trigger event is selected and the value capture opportunity may be fundamentally different as events play out prior to the trigger event being reached. This speaks directly to value and creates an underwriting issue when it comes to the collateral valuation analysis. On a value basis, the jury is out.
Leverage or Dilution?
This is the key point of the matter. If the SAFE construct provides common equity ownership, the issuer faces both potential financial investment leverage issues and control issues at the same time. Compared to a simple preferred security structure that provides a constant in terms of an IRR pledge, this makes the SAFE somewhat problematic as the new kid. Bottom line: leverage and dilution would require additional explanation and analysis – never a good thing for investors (who seek simplicity) and issuers who seek money (and need simplicity to get it).
What is the Business Deal & Value Proposition We Want to Exploit?
The real issue – at the end of it all – is the value proposition the issuer is trying to convey that is available for both the issuer and the investor to share if things work out. If things don’t work out, the value proposition is meaningless. SAFE securities represent a value proposition that may be a moving target, so care and due diligence is required in assessing the opportunity. The question would always be (from an underwriting point of view): why are we using this structure versus a preferred security or something even simpler such as a revenue participation certificate that captures value and income on a perpetual basis as the business grows?
There are many reasons why promoters may seek to offer SAFE securities but it should not be based upon the name, alone. Both the issuer and the investor need to understand what the business deal means when the SAFE is issued and when the SAFE is exercised. Get good legal advice and demand due diligence that backs up everything.