COMMENTARY: SEC rightly concerned about ‘so-called SAFE’ securities in crowdfunding

Share

ReutersJoe Green | June 1, 2017

Traders work on the floor of the New York Stock Exchange (NYSE) February 24, 2016.

NEW YORK (Thomson Reuters Regulatory Intelligence) - The U.S. Securities and Exchange Commission, released an investor bulletin earlier this month (here) cautioning retail investors about the risks of purchasing a particular type of security known as a Simple Agreement for Future Equity, or SAFE, in investment crowdfunding offerings. The commission acted following concerns raised by two of its commissioners and its Office of Investor Advocacy. It was right to do so.

INVESTMENT CROWDFUNDING

Regulation Crowdfunding — the SEC's rules allowing startups and small businesses to raise just over $1 million of capital from non-accredited, retail investors through online crowdfunding portals — became effective a year ago this month. These long-awaited regulations implemented the crowdfunding provisions of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012. Unlike popular crowdfunding platforms like Kickstarter, through which participants can make donations to for-profit businesses in exchange for rewards, investors participating in offerings under Regulation Crowdfunding receive securities (such as equity or debt) in exchange for their investments in fledgling companies.

See: SEC Approves Title III of JOBS Act, Equity Crowdfunding with Non-Accredited

The SEC's Division of Economic and Risk Analysis (DERA) has published a white paper analyzing all offerings launched under Regulation Crowdfunding from its May 16, 2016, effective date through the end of that year. To give a sense of the types of companies that have tried to raise capital using investment crowdfunding, according to DERA, the median issuer under Regulation Crowdfunding was incorporated within the last two years and had only three employees, no revenues and around $5,000 in cash and $10,000 in debt on its balance sheet. About 60 percent of crowdfunding issuers showed no revenues and 91 percent had yet to earn a profit.

When the SEC analysts looked at the types of securities that Regulation Crowdfunding issuers chose to offer to prospective investors, they found that common and preferred equity were most frequently offered, accounting for more than a third of the offerings. However, the next most commonly offered security, accounting for just over a quarter of the offerings, was the SAFE.

THE SIMPLE AGREEMENT FOR FUTURE EQUITY

As I described at length in a 2014 Hastings Law Journal article on contractual innovation in venture capital (here) that I co-authored with John Coyle, an associate professor at the University of North Carolina at Chapel Hill, the SAFE is a relatively new startup financing instrument developed and popularized by the influential Silicon Valley startup accelerator Y Combinator. The SAFE was designed to facilitate investments by wealthy, sophisticated angel investors in early-stage technology startups that were expected to raise institutional venture capital (VC) in the near future.

A type of deferred equity contract, SAFEs entitle investors to receive a company's equity securities upon certain triggering events, such as a subsequent VC investment. Unlike their close cousins, convertible notes, SAFEs do not accrue interest while outstanding and have no maturity date. The percentage of the company's equity a SAFE investor may eventually receive upon a subsequent financing is a function of the amount invested and the valuation of the company that is negotiated by the later VC investor. Conversion of the SAFE into equity depends upon that future VC financing actually coming to fruition.

Continue to the full article --> here

The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

Share

Leave a Reply

Your email address will not be published. Required fields are marked *