Blog Post

Are SAFE Investments Really Safe?

nat rosasco • Jul 26, 2018

Originally created for accredited investors in 2013, the simple agreement for future equity, or “SAFE,” has become a popular crowdfunding tool for attracting all investor-types. With a SAFE, the company takes in capital investment with the promise that it will return equity to investors upon a significant event, such as a buy-out, merger or preferred stock offering. The SAFE seems ideal for crowdfunding because the company’s lack of a then-current legal obligation to SAFE investors reduces the paperwork and maneuvering necessary to keep the founders in control of their business.

 

But is the SAFE really a safe investment? If you equate that to mean a guaranteed return, then no, the SAFE is certainly not safe. In fact, the SEC issued its own alert[1] to warn investors of the pitfalls in using a SAFE investment. After all, the SAFE is an investment, and all investments come with risk. In this article, I’ll explain how the SAFE differs from traditional investments and outline some issues for you to keep in mind when considering your own SAFE investment.

 

The SAFE is its own unique investment vehicle.

A good place to start understanding the SAFE is to realize what it isn’t. People tend to lump investments into one of two categories: debt and equity. The SAFE is neither.

 

When you invest your money with a SAFE, you’re not giving the company a loan and the company isn’t handing you a note. In fact, the company has no legal obligation to pay you if the future events that trigger your return never happen. And, unlike a loan, your SAFE investment doesn’t accrue any interest no matter how long you wait for those future events.

 

A SAFE investment also won’t grant you any stake in the company. At the time of your investment, the company hands you a promise for future equity if the company realizes a certain event. If that event never happens, you don’t get equity. Your SAFE also doesn’t get you voting rights or other similar perks that typically come along with an equity investment. When investing with a SAFE, you literally hand over your money to the founders and, well, you wait. So, don’t expect your SAFE to provide returns like a traditional debt or equity investment.

 

To be fair, your SAFE investment can become equity at some point, but you definitely do not have any stake in the company at the time you make your investment. If – and only if – the company triggers a defined future event, then – and only then – will your investment convert to a stake in the company.

 

What to watch out for when considering a SAFE.

First and foremost, you must understand the future events that will trigger your return As I mentioned previously, typical SAFE triggers include a buy-out, merger, and preferred stock offering, and other events that generally involve a significant influx of outside capital. But don’t assume the SAFE you’re considering covers every scenario in which the company is doing well. For example, if the company is earning income by selling its products or services, then your SAFE return may not be triggered even though the company is making money. Remember, your stake only vests when those triggers defined in the SAFE actually occur, not necessarily when the company becomes successful.

 

There are other issues to spot when reviewing a SAFE, especially in the crowdfunding realm. Consider the impact of the number of investors likely to join you in a SAFE investment crowdfunding offering. In that scenario, the company will likely not want to negotiate with hundreds of investors to later modify the SAFE terms. After all, startups change considerably over short periods of time and SAFEs have no expiration. Check to see if the SAFE designates one investor or subset of investors with the power to amend the SAFE for all of the investors. The SAFE may identify this lead investor or investor group by its investment amount, thus creating majority and minority investors within the SAFE.

 

You should also be aware of repurchase rights. Your SAFE may provide the company with the option to pay you for your investment even after a triggering event. In that case, understand how the company values your investment. Be wary of the company undervaluing your investment by using either its own method or through an appraiser of its choosing. Also, review any future limitation on your potential equity stake, such as reduced voting rights. All equity isn’t necessarily created equal.

 

The SAFE can be a viable investment option that helps startups succeed and genuinely rewards investors when the company is successful. It could fit your budget and goals, and allow you to participate in a company you believe in. Just make sure to read, understand and scrutinize the terms of the SAFE you’re considering, and ask a professional for help before making a significant investment that may not align with your expectations.


[1] https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_safes

Options for Addressing Title Encumbrances in Loan Transactions

By Jordan Uditsky • 04 Jan, 2022
An amendment to the Mechanics Lien Act (the "Act') permits the bonding over of mechanic's liens in the State of Illinois. The bill was signed into law ( 770 ILCS 60/38.1 ) on July 28, 2015, and went into effect on January 1, 2016. This statute is significant because it allows parties to "clear title" to real property that would otherwise be subject to a mechanic's lien. An eligible applicant will be permitted to substitute a bond for the real property subject to the underlying mechanic's lien so that the lien attaches to the bond instead of the real property. Who is Eligible? To take advantage of 770 ILCS 60/38.1 , the party desiring to bond over the lien must be an eligible applicant. The statute defines applicant relatively broadly to include the following parties: An owner; Other lien claimant; A party that has an interest in the property subject to the lien claim; An association representing owners organized under any statute or to which the Common Interest Community Association Act applies; or Any person who may be liable for the payment of the lien claim, including an owner, former owner, association representing owners organized under any statute or to which the Common Interest Community Association Act applies, or the contractor or subcontractor. Process for Filing a Petition To effectively substitute the bond for the real property, the applicant must file a petition with the clerk of the circuit court in the county where the property subject to the underlying lien claim is located. The petition must include the following: The name and address of the applicant and the applicant's attorney, if any; The name and address of the lien claimant; If there is a pending action to enforce the claim, the name of the attorney of record, or if there is no pending claim, but the claim has been recorded, the name of the preparer of the lien claim; The name and address of the owner of record of any real estate subject to the claim or the name and address of the homeowners association or the condominium association; A legal description of the property; A copy of the lien claim; A copy of the proposed eligible surety bond; A certified copy of the surety's certificate of authority from the Department of Insurance or the state agency charged with the duty to issue the certificate; and An undertaking by the applicant to replace the bond with another eligible surety bond in the event that the proposed eligible surety bond ceases to be an eligible bond. After filing a proper petition, the applicant must provide notice and a copy of the petition, either by personal service or certified mail, to every party whose name and address is stated in the petition and the lien party's attorney of record. Jordan Uditsky, an accomplished businessman and seasoned attorney, combines his experience as a legal counselor and successful entrepreneur to advise business owners in the Chicago area.

On the Move: Legal Issues Affecting Motor Vehicle Manufacturer and Dealer Law

By Lou Chronowski • 10 Nov, 2021
“Pandemic Impact? - New York Federal Court Allows Termination Dispute to Proceed” 

On the Move: The Future is Now!

By Lou Chronowski • 19 Oct, 2021
Welcome to GHU’s newest blog – On the Move: The Future is Now! This blog focuses on legal and policy issues facing the vehicle industry. The future is now for the vehicle industry. Some states (CA and MA) have issued mandates requiring that vehicle manufacturers stop selling new ICE (internal combustion engine) vehicles by 2035. Most legacy vehicle manufacturers have made various announcements stating that their respective product portfolios will move from ICE to zero emission vehicles (EVs) over the next 10-14 years. Another significant issue facing the issue relates to how vehicles are purchased. Over the past several years, Tesla has charted a distribution model that rejects traditional dealerships and uses direct sales and service. Other EV manufacturers like Rivian and Lucid appear to be headed in a similar direction. It is well known that Apple and Amazon have plans to enter the vehicle space as well. Consumers will have a large role in determining how they want to purchase vehicles and vehicle services (much the same as they did with respect to on-demand transportation with the likes of Uber and Lyft). The question is whether traditional manufacturers will be kept on an uneven playing field with these newer market entrants. Finally, autonomous vehicles (AVs) are right around the corner as well. In addition to consumer adoption and acceptance of EVs, it is still unknown how consumers will react to AVs and whether AVs have a large role in America. The future is now. The changes in the industry are happening now and happening at fast pace. This blog will continue to explore issues facing the vehicle industry. For 20 years, Lou Chronowski has represented motor vehicle manufacturers helping them navigate complex laws and regulations and litigating disputes against dealers. If you have any questions, please contact Lou at lchronowski@ghulaw.com .
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