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SAFEs & tech-based economic development

June 21, 2018
By: Robert Ksiazkiewicz

Part 1 of this series on SAFEs (simple agreements for future equity) focused on the investment vehicle and its pros and cons, and can be found here.

In this second article in a series on SAFEs, we examine how the investment contracts may be used by venture development organizations (VDOs), entrepreneurial support organizations, and other investment-focused economic development entities. These public/nonprofit capital providers may increasingly face exposure to SAFEs from the changing private market as their region’s private accelerators, super angels, and other private investors shift from convertible notes to SAFEs during the early-stage investment process.

In regions where private investors have made the transition from convertible notes, economic development organizations have already had to consider how to work on deals that include SAFEs. This includes some economic development organizations transitioning to SAFEs from convertible notes to stay current with their local private market and align with partner organizations. 

Conversely, in regions that are slow to adopt SAFEs because of investors’ unfamiliarity or concerns with the agreement structures, economic development organizations may be slower to adopt SAFEs. This contrast in adoption highlights the importance of economic development organizations aligning their investment agreement structures with partner organizations as well as considering the preferences of later-stage regional investors. If regional VCs have hesitancies to complete deals due to SAFEs, economic development organizations have little incentive to make the switch over to SAFEs.

Economic development organizations also must consider the best structure for the client companies that comprise their investment portfolio. SAFEs were developed, in large part, to serve as a bridge investment for high growth startups that were in need of a short-term capital infusion. It was essentially made to help likely gazelle companies move closer to an exit for the SAFE investor. It is especially effective, and much more favorable for investors, if the company has a clear path and timeline to a triggering event.

For VDOs, accelerators and other economic development organizations focused on helping high growth companies achieve an exit or new round of VC funding quickly, the SAFE may be a very appropriate, cost-effective, straightforward investment structure because some of the risks of SAFEs are mitigated (e.g., no maturity dates and no rights in the event a company defaults). Conversely, if an economic development organization is working with a company that may take longer to achieve a trigger event, has low potential to attract VC funding, or may become a lifestyle company, it may be a better strategy to focus on offering a standardized convertible note agreement.

Due to the limited, pre-determined terms of SAFEs, economic development organizations also must consider how to reduce their risk and achieve organizational objectives such as job creation. One potential solution may be the development of a side letter agreement that provides the economic development organization with additional rights such as board observation, economic impact reporting, economic development clawback, etc. Some economic development organizations have started to use a hybrid agreement structure that combines elements of SAFEs with convertible notes to create a more investor-friendly agreement that provides extra protections and rights for the investor.

 

capital