Important Information about Raising Investor Capital with a SAFE (Simple Agreement for Future Equity).
As popular as they are, Y-Combinator Simple Agreements for Future Equity (“SAFEs”) forms do not satisfy an issuer’s (the startup selling SAFEs to investors) state or federal securities law disclosure and filing obligations. The Security and Exchange Commission (the “SEC”) has affirmatively determined that SAFEs are in fact securities and that issuers of SAFEs must either register the offering with the SEC or qualify for an exemption from registration. Due to the expense and time involved in the registration process, most startups issuing SAFEs rely on Rule 506(b) of Regulation D.
Rule 506(b) allows issuers to raise an unlimited amount of investor capital to an unlimited number of “accredited investors” and up to 35 “sophisticated investors.” Issuers are required to disclose all of the material terms of the offering (e.g., total amount being raised, offering period, minimum investment amount, whether the offering is being held on a minimum/maximum basis or best efforts basis, whether there are oversubscription rights, whether there are offering period extension rights, etc.) and material disclosures about the issuer itself (e.g., the existence of any pending or threatened lawsuits or government actions, conflicts of interest, capitalization of the company, financial statements, intellectual property rights, use of proceeds, compliance with law, voting rights (or lack thereof), etc.). What’s more, if the issuer is raising any capital from a “sophisticated investor,” its disclosure obligations significantly increase and require risk factor disclosures and a whole host of other disclosures that are akin to the disclosures that need to be made in a registered offering (think of a prospectus).
Lastly, issuers leveraging the Rule 506(b) exemption must also file a Form D with the SEC no later than 15 days after the first date of sale of a SAFE, as well as “blue sky” Form D notice filings with each state in which an investor is located. An issuer’s failure to comply with these laws could result in civil penalties with securities regulators (e.g., fines, prohibition on raising investor capital moving forward, etc.), civil claims by investors, and even criminal prosecution. This also routinely comes up as an unfixable problem during due diligence in future investor rounds and the exit transaction.
We understand that many of our clients are startups running on tight budgets. The good news is that making sure they are using qualified legal counsel to draft the additional agreements and disclosures needed to comply with securities laws, and prepare and file the necessary state and federal securities filings, is not super expensive and can be funded by a portion of the investor capital being raised in the offering (so long as that is properly disclosed to the investors). If you’re considering raising investor capital through the issuance of SAFEs, please reach out to us at [email protected] to discuss and obtain a quote.