The Securities and Exchange Commission‘s message in its Tuesday investor bulletin on Simple Agreement for Future Equity securities was clear: Be wary of opportunities bearing names too good to be true.
The SAFE investment vehicles, as they’re known, were created to facilitate a faster, less cumbersome way for Silicon Valley venture capitalist-type investors to get in on the absolute ground floor of promising new companies. Unlike convertible notes with a built-in guarantee of some sort of maturity date or interest, SAFEs allow investors to provide upfront capital in exchange for future access to equity in the company—but only after a “triggering” event has occurred, such as being acquired or another round of financing.
These kind of simple deals may work for investors with the savvy—and liquidity—to spot a potential winner and take a risky bet. But SAFEs have begun appearing on crowdfunding portals, the SEC warned, where they have the potential to be deployed to raise capital in situations they weren’t originally intended for.
The SEC’s concern is that investors in the dark over the terms of the SAFE could be stuck in perpetual limbo in the event the company never actually initiates the agreed-upon trigger.
“SAFEs were developed in Silicon Valley as a way for venture capital investors to quickly invest in a hot startup without burdening the startup with the more labored negotiations an equity offering may entail,” the SEC warned. “This may or may not be the case with the crowdfunding investment opportunity you are exploring.”
While SAFEs in and of themselves can be highly effective ways of attracting investors in specific situations, the SEC’s red flag has attorneys concerned about impacts on all the parties involved. The name itself likely gives rise to concerns over just how these instruments are being presented to crowdfunding investors.
“If I am a crowdfunding website, I think you have to regard the SEC announcement as putting you on notice in terms of liability or concern as to making SAFE available,” said Don Hawthorne, partner at Axinn, Veltrop & Harkrider.
The SEC’s notice is likely to serve as a warning to companies and portals about overselling the nature of the investment. As Boies Schiller Flexner partner Andrew Michaelson notes, the origin of SAFEs lie in an investment environment around Silicon Valley startups that have done a good job of promoting these kinds of investments.
“The concern is that it’s a frothy market and investors get excited about hype and unicorns, and maybe companies aren’t fully forthcoming about the risk out there,” he said. “The risk of lawsuits increases where investors do not understand the terms of their SAFE, which can be highly technical.”
The issue then is less about the terms of the SAFE—which are by design very simple—and more about the civil liability in the nature of the company itself living up to what is advertised.
“You can just see the civil suits lining up,” Michaelson said.
The SEC’s bulletin may serve as a kind of language shield for both companies and portals looking to protect themselves when offering SAFEs.
“You may see some of this language popping up in the offering document,” Hunton & Williams’ partner Scott Kimpel said. “This is where the agency can be helpful; this warning is out there.”