That said, there are also negative points for investors. First of all, it is not clear what an investor actually has when he buys a SAFE. There is no expiration date or maturity date, so it may take years before a conversion to shares occurs, or it may never happen. Second, an investor has no shareholder rights until the SAFE is converted into shares. Therefore, a SAFE holder does not have the authority to participate in a board election or participate in dividends. Third, if the company is dissolved, SAFERs are subordinated to outstanding debts and creditors` claims (but generally take precedence over payments to common shares). As we mentioned earlier, SAFE agreements are relatively new to Canada and, as a result, people looking to start a Canadian start-up, and even some investors, may not be aware of them. If you need help, OMQ Law`s in-house lawyers in Toronto can help you review a SAFE agreement and explain the terms and conditions of the agreement. Call OMQ Law for a free consultation.
A SAFE (simple agreement for future equity) is an agreement between an investor and a company that grants the investor rights for future equity in the company similar to a warrant, unless it is a certain price per share at the time of the initial investment. The SAFE investor receives the futures shares when a round or liquidity event occurs. SAFERs are intended to provide a simpler mechanism for startups to apply for upfront funding than convertible bonds. While the terms of SAFE seem to make it clear that these are not debt instruments, the correct tax treatment of a SAFE is an open topic and often a complexity of a SAFE that is overlooked by investors and companies at the time of sale. Depending on the terms of the SAFE and the facts and circumstances relevant to its issuance, a SAFE must be treated as an equity futures contract or a variable prepaid futures contract from the perspective of U.S. federal income tax. Despite the positives, there are a few drawbacks that founders should be aware of. Often, founders include a valuation cap in a SAFE and raise funds in the hope that they will dilute their share of ownership based on that valuation. It is important to remember that the valuation cap is not necessarily the valuation at which the capital is raised. Suppose a founder raised $500,000 in startup capital on a SAFE.
The SAFE conversion event is a $1 million share round (commonly referred to as the Series A round), and equity is converted to the lower value of a $10 million valuation cap or 20% discount. If the company is forced to raise $1 million at a $6 million valuation due to a liquidity crisis or other market factors, the founders have abandoned 27% of their company, compared to 16% they would have expected at a $10 million valuation.2 Issues like these have the potential to relate to the SAFE deal, the resulting equity, and the investor`s belief in success and the ability to grow your business. Contact a financial lawyer to better understand your startup`s financial dynamics in relation to a SAFE agreement. The EBC Tax Credit is, in simple terms, a 30% tax credit in British Columbia that investors receive for investments in small businesses operating in eligible industries in British Columbia. For an investor to receive the tax credit: the business must operate in an eligible industry; registered for the EBC loan; the investment structure must be eligible; and the funds must be allocated and made available to the company for the issuance of the loan. The industries eligible for the credit are quite broad and include: manufacturing; research and development of new technologies; destination tourism; digital media products; Clean technologies and advanced commercialization. British Columbia also offers a similar tax credit for venture capital firms that operate under the same overall program. If it is a share financing event, the SAFE holder may convert the SAFE into shares at a predetermined price. If the triggering event is a liquidity event, the investor will either receive a payment equal to the purchased value of the SAFE, or the startup will issue shares that correspond to the safe purchase price divided by a liquidity price also predefined in the SAFE. A SAFE is a useful tool for start-ups looking to raise capital without incurring the higher costs and lengthy negotiations associated with more traditional financing methods.
Nevertheless, it is important for founders to think carefully about how much equity they are willing to give up and for investors to keep in mind that they have no shareholder rights and have no recourse if a conversion to shares does not take place. One of the biggest advantages of SAFE for founders is the ability to close a financing with an investor on an individual basis, rather than coordinating a single transaction with multiple investors – often a stressful and expensive process. This feature, in fact, creates a staggered capital raising process that allows founders to better manage the amount of equity to be offered (so that it is not diluted more than necessary) and ensures that the company is not overcapitalized. Another advantage is that issuers spend less on lawyers and save time in negotiations because the agreement does not contain complex terms compared to more traditional financing methods. Finally, because there are no equity funding maturity dates or deadlines, founders can focus on growing their business without the overhead stress that debt or financing maturities cause. A SAFE agreement is a financial contract between startups and investors. The SAFE agreement was developed in 2013 by YCombinator, an accelerator in the United States, and was launched to streamline the seed funding process for emerging startups. This was an efficient and much easier way to generate funding than traditional convertible bonds. A futures contract is a contract performed under which the buyer agrees to purchase a fixed amount of goods from the seller at a fixed price in the future. In the case of a variable prepaid futures contract (“VPFC”), the buyer pays the seller the purchase price at the time of conclusion of the contract and not at the time of delivery of the property, and a variable amount of ownership is transferred upon conclusion of the contract. A SAFE is similar to a VPFC contract in that the investor acquires the capital (in cash or by providing services) under a contract with a contractually agreed amount of ownership that varies depending on the circumstances and must be delivered later. Y-Combinator designed SAFERs as quick and easy documents.
However, complexity is more likely to occur or be discovered after the SAFE is issued than before or during the safe is issued. As we have seen in this article, one complexity often overlooked by investors (and companies) is the tax treatment of SAFE. Unless a SAFE is treated as initial capital, investors who buy SAFE instead of shares delay the start of the capital gains clock (one year) and the “eligible small business shares” clock (five years), which could mean they could forego significant tax benefits. Investors and issuers should discuss the tax treatment of receiving a SAFE based on the particular circumstances in which the SAFE was issued. While it seems clear that a SAFE should not be treated as a debt for tax purposes, it is advantageous for a SAFE holder to understand in advance the treatment of the SAFE for tax purposes, as this may affect the nature of the gain from the sale of the underlying share of the SAFE. A SAFE is a convertible security that generally has no debt component or expiry/maturity date (i.e. no repayment obligation). Investors who participate in a SAFE acquire an option to convert their investment into shares of the company at a later date when a predetermined event occurs. This conversion event usually occurs when the entity enters into equity financing for total proceeds traded..
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