Fundraising Agreements: Part 2 - SAFE for Non-U.S. Investors (Reg-S)

?? Overview of the SAFE

The Simple Agreement for Future Equity (SAFE) was introduced by Y Combinator in 2013 as a novel financial instrument designed to simplify the process of early-stage funding. It was created as a more efficient and founder-friendly alternative to traditional financing methods for startups. The SAFE is a form of investment that allows startups to receive immediate funding from investors in exchange for future equity during a subsequent financing round.

??? Regulatory S Framework

Regulation S is designed to facilitate international investment in U.S. securities by providing a path for U.S. and foreign issuers to engage with non-U.S. investors without the extensive requirements of SEC registration, assuming the transaction does not target the U.S. market.

• Regulation S Exemption: Provides an exclusion from SEC registration for securities offerings made outside the U.S.
• Issuer and Resale Safe Harbors: Available if the sale is an offshore transaction without directed selling efforts in the U.S.
• Eligibility: U.S. and foreign issuers, distributors, and affiliates can rely on Regulation S.
• Exclusions: Not available for certain investment companies under the 1940 Act.
• Requirements: Offshore transactions without directed selling efforts in the U.S.
• Categories of Transactions: Different categories under Rule 903, each with specific restrictions based on the likelihood of securities flowing back to the U.S.
• Distribution Compliance Period: Varies by category and type of securities, restricting sales to U.S. persons.
• Types of Offerings: Covers standalone, combined with Rule 144A, and continuous offerings, among others.
• Concurrent Offerings: Regulation S offerings can be conducted alongside other exempt offerings without integration.
• Legends and Disclosures: Specific legends and statements are required on offering materials.
• "Offshore Transaction" and "Directed Selling Efforts": Definitions and criteria are provided to ensure compliance.

???? Compliance Under Reg S

For issuers to comply, the offering must be conducted outside of U.S. markets, without any marketing efforts aimed at U.S. investors. The securities must not be sold to U.S. persons for a set period unless they are registered or fit another exemption, and they must carry specific legends denoting these restrictions.

To comply with Reg S and ensure that a SAFE offering is exempt from registration, issuers must adhere to the following:

1.???? Offshore Transactions: Offers must be made in offshore transactions, with no directed selling efforts made in the United States.

2.???? Directed Selling Efforts: Issuers must refrain from any activity that could condition the market in the United States for the securities offered under Reg S.

3.???? Distribution Compliance Period: Equity securities issued under Reg S are subject to a distribution compliance period, typically one year for equity, during which they cannot be resold to U.S. persons unless under another exemption.

4.???? Transfer Restrictions: Securities must have transfer restrictions and carry legends denoting such, and the issuer's organizational documents must reflect these restrictions.

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?? Offering SAFEs to Non-U.S. Investors

Companies should ensure that the SAFE represents future equity without setting a price, addressing valuation caps, and discounts. They must clearly articulate the conditions under which non-U.S. investors will gain equity, typically upon a significant financing event or company sale. Both startups and investors must be aware of the risks involved, such as potential dilution or the lack of conversion triggers.

1.???? Securities Structure: Like any SAFE, it confers future equity rights without setting a specific price per share at the initial investment, which includes negotiating valuation caps, discounts, and investment amounts.

2.???? Investor Rights: Non-U.S. investors gain the right to future equity, typically at a discounted price, upon a future equity financing round or sale of the company.

3.???? Risks for Startups: Startups must be aware of giving steep discounts, negotiating additional terms, representing SAFEs in a cap table, and ensuring proper legal and accounting advice.

4.???? Risks for Investors: Investors face the risk that they may not trigger a conversion into equity if there is no future equity financing or if the company is not sold.

?? Legal Considerations

Issuers must draft comprehensive legal documents that define the rights and obligations under the SAFE, conduct due diligence to verify the status of investors, and seek legal and accounting advice to ensure compliance with Regulation S and broader securities laws.

1.???? Legal Documentation: Proper legal documentation is vital, ensuring that the terms of the SAFE are clear and that the rights and obligations of the parties are well-defined and comply with Reg S requirements.

2.???? Due Diligence: Startups must perform due diligence to ensure that potential investors are genuinely non-U.S. persons and that the offering complies with Reg-S.

3.???? Legal and Accounting Advice: It is crucial for startups to obtain proper legal and accounting advice to ensure compliance with securities regulations and to avoid costly enforcement actions.

?? Conclusion

Leveraging SAFEs for non-U.S. investors requires a strategic legal approach to comply with Regulation S. While SAFEs provide flexible financing options, startups must carefully navigate the legalities to maintain fundraising integrity and protect their interests.

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