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SAFE Discounts Should Be 50% At Least

When Title III equity crowdfunding launched on May 16, 2016, a majority of the 20 equity offerings listed on Wefunder, the dominant Title III portal, used a new security called SAFE. That’s an acronym for simple agreement for future equity.

The SAFE is like a warrant entitling investors to shares in the company, typically preferred stock, if and when there is a future liquidity event, i.e., if and when the company next raises “priced” equity capital, or is acquired, or files an IPO.

Like convertible debt, SAFE deal terms can include valuation caps and share-price discounts, to give early (CF) investors a lower price per share than later (VC) investors or acquirers get for the same equity. That’s justice, because earlier investors take much more risk. For more details about the terms of a SAFE, see the in-depth article I wrote for Financial Poise, and the following:

  • Y Combinator’s Startup Documents page, which introduces the SAFE and give links to four different versions of the source document.
  • A 2016 National Law Review article by lawyers Stephanie Zeppa and Andrew Kreider.

The SAFE offers investors less protection than convertible debt. For taking such a great risk, investors should be very generously rewarded, right? It seems the magnitude of the reward depends entirely on low caps and/or high discounts, since those are the only variable terms.

Experienced angel investors are skeptical about whether issuers are willing to offer sufficiently generous discounts in particular. Of the 11 issuers that use SAFEs for their offerings on Wefunder, all include valuation caps (ranging from $2 million to $20 million) but only two include discounts (10 and 15 percent). Considering the much greater level of risk that seed-stage investors take on compared to later-stage investors, 15 percent might not seem like much of a reward to sophisticated angel investors — it means the company’s value has increased very little since the CF funding round. Try 50 percent, which would represent a 2x valuation jump from the CF round to the VC round, quite reasonable when the time between events is indefinite.

Title III Investors

Crowdfunding investors under Title III will be more socially motivated than traditional angels whose primary motivation is ROI. Average Title III investors (a) will gravitate to the exquisite simplicity of the SAFE, (b) will not know if the valuation cap is meaningful, and (c) will often settle for a half-decent discount on share price just to get in on the ground floor of an exciting startup — a privilege that was largely unavailable to them before Title IIec4iI of the Jumpstart Our Business Startups Act of 2012 was implemented this year.

Many Title III investors’ primary motivation will be to help entrepreneurs they admire, support community development, own a piece of their favorite hangout or brand, or simply have as much fun as those “Shark Tank” investors seem to have. Again, many experienced angels may disagree with that approach, because they must maximize return on investment every time in order to be successful — that’s their full-time job.

About David M. Freedman

David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…

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