There are several different ways a company can raise money. Companies can choose to raise funds through either debt or equity offerings. Debt raising usually involves some form of loan that must be repaid in the future. While raising funds through equity means the funds raised do not need to be paid back, the company must forego some ownership (in the form of shares) in exchange for that money. One way that businesses raise money is via a SAFE note. SAFE stands for simple agreement for future equity and, as the name suggests, is a type of equity arrangement. This article will explain what legal considerations you should evaluate when raising funds via a SAFE note issuance in New Zealand.
How Does a SAFE Work?
A SAFE is a type of convertible security that allows an investor to receive equity at some point in the future. Many startups are difficult to value, so a SAFE alleviates this problem. An investor provides money to a business on the basis that once the company is valued and a priced round occurs, the investor will receive shares having an equivalent value to the amount invested. To reward investors for their early commitment to the company, often the conversion into shares occurs at a discount i.e. their shares will be priced at a 20% discount to the price paid by investors coming in on the priced round.
Differences Between a SAFE and a Convertible Note
Another option is to raise funds via a convertible note. Unlike a SAFE, a convertible note has a debt element and effectively acts as a loan incurring interest until the conversion into equity at the maturity date. A convertible note gives the investor more benefits. This is because the investor covers their downside if the company’s value is less than expected.
Interest Rates
The main difference between a SAFE and a convertible note is that there is no interest element for a SAFE. A SAFE is purely an equity instrument. On the other hand, a convertible note is a hybrid debt/equity instrument that acts as a loan in the short term. This means that the company must carefully negotiate the interest rate and maturity date that applies to the convertible note. This is an important step of the process as it acts as cash flow for the investor and an expense for the business.
Liquidity Event
It is important to determine the process for both a SAFE and a convertible note in case of a liquidity event. A liquidity event includes any major asset sale, a share sale or an initial public offering. Typically, on a liquidity event, the SAFE or convertible note will convert into equity directly before the liquidity event occurs. This ensures the investor receives value for their investment.
Continue reading this article below the formLegal Considerations when Implementing a SAFE in NZ
Disclosure Obligations
Given a SAFE is an equity instrument, the disclosure obligations under the Financial Markets Conduct Act 2013 apply. Typically, startups will look to rely on the limited disclosure exemptions that are available under Schedule 1 of that Act. You should seek legal advice before issuing any SAFE (or other equity instruments) to ensure you understand your compliance obligations.
SAFE Agreement
When implementing a SAFE, you will need to put in place a formal agreement. A SAFE agreement is a legal contract that contains all the key agreed commercial terms of the SAFE. SAFEs are increasingly popular in New Zealand. There are standard form industry template documents that parties use to document the terms of the SAFE. It is often recommended to use these forms as the base document for your SAFE. This is because it limits your time and cost spent on negotiating the terms.
Capital raising is a critical time for any startup. Take control of your startup’s equity with this free cap table template. It will also allow you to analyse and compare financing rounds to make the best capital raising decisions.
Conversion Event
Before putting in place a SAFE, you will need to consider what constitutes the conversion or “trigger” event. This is the point in time when the SAFE becomes equity, and the investor becomes a shareholder in the business. The timing of the conversion event needs to be carefully negotiated and outlined in the SAFE agreement. The conversion event typically triggers during a round of funding so that the company obtains an accurate valuation.
Key Takeaways
You may need to bring on investors to assist with growing your business. Investors are able to inject capital into your business which helps you expand your company. There are several different ways that this can occur, and one of these includes a SAFE. A SAFE is a simple agreement for future equity and allows an investor to inject capital into a business before a value is attached. At a future date, the investor will receive shares in consideration of their early investment. This will usually occur once the company has been valued at a future round of funding. As with all arrangements, there are certain legal considerations you should consider, such as the SAFE agreement and the conversion event.
If you need help with SAFEs, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.
Frequently Asked Questions
Not necessarily. A SAFE will convert on a liquidity event or a pre-agreed “trigger” event If neither of those events occurs, the SAFE will not convert.
If the SAFE agreement contains all the elements of a binding contract, then it is legally enforceable.
We appreciate your feedback – your submission has been successfully received.
