Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

In remarks at the Annual SEC/NASAA Conference, SEC Commissioner Michael S. Piwowar focused on the suitability and adequacy of disclosure of a security known as a “SAFE” that has been used in crowdfunding transactions. SAFE is an acronym for “simple agreement for future equity.”  The terms of the security were outlined in a Virginia Law Review Online article authored by Joseph Green and John Coyle. The article describes the terms of the security as follows:

Although the SAFE resembles a classic seed-stage convertible note in most respects, it lacks the convertible note’s maturity date and does not accrue interest while it remains outstanding. It does not pay dividends, and the SAFE holder has no right to vote on matters submitted to shareholders. The SAFE is, in essence, a contractual derivative instrument that amounts to a deferred equity investment. It will prove valuable to the holder if, and only if, the company that issues it raises a subsequent round of financing, is sold or goes public.

The key problem with the use of SAFEs in crowdfunding is that many of the companies issuing them are unlikely ever to raise institutional venture capital. If a crowdfunding issuer never raises this type of capital, then the retail investors who hold that issuer’s SAFEs may find themselves in possession of a security that, in addition to granting the holder no voting rights or other investor protections, may never provide them with a return on their capital — or a return of their original investment amount — even if the company is successful.

As Commissioner Piwowar put it, “The terms of the SAFE, from the triggering events to the conversion terms, are typically designed to operate in the context of a fast-growing startup likely to need and attract future capital from sophisticated venture capital investors.”

Commissioner Piwowar described the challenges of using SAFEs in connection with a Regulation Crowdfunding transaction as follows:

In contrast to the sophisticated venture capital investors for whom SAFEs were originally intended, Regulation Crowdfunding is designed to serve as a new method of raising capital from a broad, mostly retail base of investors. Regulation Crowdfunding thus requires the intermediary facilitating the offering to provide investors with educational materials, including information about the types of securities offered and sold on the intermediary’s platform and the risks associated with each type of security.  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.