SAFE Financing

Everything you need to know about raising money with a SAFE Financing over Goodlawyer.

1. What is a SAFE Financing?
2. Pricing and Scope
3. What is the Process?
4. Advantages of a SAFE Financing
5. Frequently Asked Questions
6. Book a SAFE Financing

 

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What is a SAFE Financing?

The Simple Agreement for Future Equity (SAFE) is a standardized financing instrument used by some startups to raise capital in early-stage financing rounds. The SAFE was invented in 2013 (and updated and re-released in 2018) by Silicon Valley incubator, Y-Combinator, as an alternative financing instrument to Convertible Notes and series seed preferred equity: two early-stage fundraising instruments also favoured by Angel Investors. 

In Canada, the SAFE investment contract primarily follows one of two template forms:

• The Y-Combinator Canada SAFE
• The National Angel Capital Organization (NACO) Canadian SAFE 

A SAFE investment contract is entered into between a startup and an investor and gives the investor the right to receive equity of the company in the future on the occurrence of certain standardized triggering events, namely a:

• Future equity financing, usually led by an institutional Venture Capital (VC) fund
• Sale of the company

The SAFE conversion features are very similar to the conversion features of Convertible Notes. However, SAFEs are NOT debt instruments. SAFEs are “convertible equity” and, unlike Convertible Notes, do not:

• Mature or expire. Until a conversion event occurs, SAFEs remain outstanding indefinitely
• Accrue interest. Investors receive only a right to convert their SAFEs into equity at a lower price than the investors in the subsequent financing. Unlike Convertible Notes, a SAFE investor’s investment does not accrue interest until it converts to equity

While more “founder friendly” than Convertible Notes, SAFE Financings are “investor friendly” since the price of the equity that the SAFE holders receive on conversion is lower than the price of the securities issued to VC investors in a triggering event, based on either of the following SAFE features:

• Discount rate
• Valuation cap
• Learn more about discount rates and valuation caps in the FAQ

SAFEs also provide that, upon a dissolution or winding-up of the corporation (which is not in connection with a sale of the corporation), the SAFE holders are entitled to receive the purchase price of their SAFEs before the equity holders receive any distribution of the corporation's residual assets. Basically, they get their money back first.

Note that SAFE Financings may not be the most appropriate investment instrument to raise capital from friends and family. SAFE Financings, although simple and efficient from a legal perspective, are a sophisticated way to raise capital from investors who understand the startup financing framework and work best for companies with a clear and foreseeable path to a “conversion event”, like a VC financing round. For a simple investment structure more suitable for early-stage fundraising from friends, family and accredited investors, we offer a Basic Equity Round financing product.

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Pricing and Scope

Because the SAFE investment contract follows a template form, the SAFE Financing is the most efficient and cost-effective fundraising solution that Goodlawyer offers. The Goodlawyer SAFE Financing is applicable to a SAFE financing round based on the Y-Combinator Canada SAFE or the NACO Canadian SAFE. Learn more in the FAQ.

If you’ve negotiated a SAFE financing round that deviates from the terms of the Y-Combinator Canada SAFE or the NACO Canadian SAFE, your lawyer will create a custom service to best suit your unique fundraising needs and goals.

 

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What is the Process?

1. Book a call: Pick a time to discuss your SAFE Financing with a Good Lawyer. They'll help you determine if it’s the right investment solution for you.
2. Design your SAFE Financing: Work with your Good Lawyer to design a SAFE Financing that meets your business’ and investors’ needs. You might need to negotiate with your investors on the deal, especially if they are exercising their right to seek independent legal advice. 
3. Draft your SAFE contracts: Work with your Good Lawyer to prepare a SAFE investment contract for each participating investor (up to 5 investors, maximum). 
4. Secure the bag: Once you and your investors agree on the deal and your lawyer has prepared a SAFE investment contract for each of your initial 5 participating investors, it’s up to you to collect signatures and get that money!

 

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Advantages of a SAFE Financing 

Drafting speed and simplicity. 

SAFE Financings are typically simpler to prepare and close than Convertible Note financing because SAFEs include fewer negotiated terms than Convertible Notes. SAFE contracts are based on standardized template forms and require negotiation of only a couple of key terms: the discount rate, and valuation cap. 

Unlike Series Seed Shares and Convertible Note financings, SAFE financings don’t require term sheets, just one signed agreement with each SAFE investor. 

Cost.

Because they are based on standardized template forms, the cost of documenting and closing a SAFE Financing is generally less expensive than a Convertible Note financing.

No interest or maturity. 

When comparing to Convertible Notes, most founders love that SAFEs do not accumulate interest, reducing their dilution at the time of conversion. The absence of a maturity date also gives founders the peace of mind to build their startup without rushing important decisions or bending to investor (creditor) pressure.

Investor familiarity.

Aside from the lack of interest and maturity, SAFEs are designed to have the same economics and mechanics as Convertible Notes, meaning most professional seed-stage investors are already familiar with their key terms and function.

 

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Frequently Asked Questions

How does the Goodlawyer Service Fee work?

Because we believe in transparent pricing, we make our best effort to be upfront about additional fees and how they are calculated.

Visit the Goodlawyer Service Fees page for a detailed explanation.

What is an Investment Readiness Assessment?

An Investment Readiness Assessment ensures your company is clean, your record-keeping is up-to-date and you are ready to efficiently close your investment round. Your Good Lawyer’s goal is to identify legal or procedural barriers to completing your investment round by checking things like articles of incorporation, shareholder agreements, share capitalization table (the “cap table” or list of who owns stock) and other documents. 

The information discovered by your Good Lawyer during the Investment Readiness Assessment helps to:

• Draft a high-quality SAFE document
• Ensure compliance with applicable securities laws, governing organizational documents and other contractual restrictions

The principal topics of review covered by your Good Lawyer in an Investment Readiness Assessment are:

• Corporate structure — organizational documents, including certificates or articles of incorporation, amalgamation or continuance, by-laws and other organizational documents relating to your company. 
• Corporate governance — minutes of your company's board of directors relating to equity issuances, as well as any documents or contracts relating to shareholders, equity issuances or pre-emptive rights.
• Share capitalization — records relating to all holders of the issued and outstanding classes and series of shares in the capital of your company, including the date of grant, purchase, or transfer. All shareholder or similar agreements to which your company is a party.
• Convertible securities — records relating to all holders of warrants, stock options or any other securities convertible, exchangeable or otherwise exercisable for any class or series of shares in the capital of your company, including date of grant, exercise price, number and type of securities, expiration date, vesting terms, and any other significant term in relation to such rights or interests.
• Promised but unissued securities — records authorizing or granting shares, options, warrants, stock options (including all stock option plans and other equity incentive plans and any shareholder rights plans) or other rights or interests in your company.
• Shareholder voting and governance arrangements — records relating to outstanding proxies, voting rights agreements and voting trusts or other assignment of rights attaching to any securities of your company.

When is a SAFE Financing appropriate?

Although simple and efficient from a legal perspective, SAFE Financings are a sophisticated way to raise capital from investors who understand the startup financing framework and work best for companies with a clear and foreseeable path to a “conversion event”, like a venture capital financing round.

Are there any disadvantages to SAFE Financings?

While SAFE Financings boast many advantages that make them attractive to startups and early-stage investors, they also come with a few disadvantages that founders should consider when picking their investment instrument.

1. Sophistication. SAFE Financings are “simple” because they are premised on standardized template forms, not because they are necessarily easy to understand. SAFE investment contracts demand sophistication to negotiate, understand and execute properly. For this reason, SAFE Financings are best suited for founders and investors who understand the startup financing framework and for companies with a clear and foreseeable path to a “conversion event”, like a venture capital financing round.
2. Dilution uncertainty. Because SAFEs convert to equity at the next liquidity event, neither the investor nor the startup knows exactly how much equity the SAFE converts into until the company completes a “conversion event”, like a venture capital financing round. Founders planning a SAFE Financing are advised to run some pro forma investment scenarios to better understand how their ownership control is impacted by various discount rates, valuation caps and conversion events.      
3. Accounting uncertainty. SAFEs are neither debt nor equity. As such, companies that raise capital using SAFEs have to work closely with their accountants and advisors to properly document their SAFE financing activities on the company’s financial statements and capitalization records.
4. Simple now, complex later. Although SAFE investment contracts make it easy to raise capital with minimal upfront legal work, legal issues and complexities often arise when a company completes a “conversion event”, like a venture capital financing round. This added complexity results from how the economic terms of the SAFEs interact with the economic terms of the preferred shares in the next financing. It is not always clear from the SAFE documents exactly which type of calculation the holders of those instruments intended at the time of the financing. Even if the method of calculation is clear from the documents, those investors may be forced into renegotiations if the investor leading the next equity financing round requires certain concessions from those investors as a condition to that investor's equity investment. The investor may seek, for instance, to calculate the conversion to minimize the ownership percentages of the SAFE holders in relation to the corporation's founders and themselves.

What terms are in a SAFE?

The key terms that founders need to understand when using a SAFE are outlined below:

1. Purchase Amount 
   1. This is the amount of money that the investor is giving the startup under the SAFE. 
2. Valuation Cap
   1. A ceiling, or cap, on the valuation at which the SAFEs convert in the next equity financing. The valuation cap prevents a scenario where the startup uses the funds from the SAFE round and builds a business with a much larger valuation at the next financing round than anticipated at the time of the SAFE. For example, you were expecting to raise a Series-A at $15 million, but you strike gold and raise at $50 million instead. This outcome would leave the SAFE investors with a much smaller ownership stake than if they had chosen to structure their investment as equity at the outset. The valuation cap ensures that SAFE investors still have a meaningful stake if your startup achieves an unusually high valuation in its next financing round. 
   2. Founders should be clear and explicit with their team and investors whether the valuation cap is based on the pre-money valuation or post-money valuation. As its name suggests, a pre-money valuation cap does not take into consideration the capital the corporation will receive in the SAFE Financing. With a post-money valuation cap, the corporation's valuation is equal to the company's pre-money valuation plus the amount invested in the corporation in the SAFE Financing.
   3. The Y-Combinator Canada SAFE uses a post-money valuation cap, whereas the NACO Canadian SAFE uses a pre-money valuation cap. Learn more below.
3. Discount Rate
   1. As a reward for investing early before a valuation is set and shares are issued, SAFE investors may receive a discount on their investment at the time of conversion. This means that the price per share used to calculate the SAFE conversion is less than the price per share of the corporation issued to the new equity investors at the next equity financing. 

1. 1. Discounts in SAFE Financings typically range between 10% to 30% off of the preferred share price, with the most common discount being 20%.
2. Equity Financing
   1. A transaction or series of transactions in which the company issues and sells preferred shares at a fixed valuation triggering the conversion of the SAFEs into the same type of equity sold in the priced equity financing. 
   2. The Y-Combinator Canada SAFE always converts into preferred shares at a next equity financing, whereas the NACO Canadian SAFE may convert into common shares or preferred shares at a next equity financing.
3. Liquidity Event
   1. A sale of the company or an initial public offering of the company’s shares triggering the conversion of the SAFEs, so that the SAFE holders can share in the proceeds of the transaction.
4. Dissolution Event 
   1. SAFEs provide that, upon a dissolution or winding-up of the corporation (which is not in connection with a sale of the corporation), the SAFE holders are entitled to receive the purchase price of their SAFEs before the equity holders receive any distribution of the corporation's residual assets.

Do SAFE Financings typically contemplate special investor rights and protections?

Holders of SAFEs do not typically receive contractual rights or protections above and beyond the ability to convert their securities into equity. In order to enhance their rights or protections investors may negotiate side letters with the corporation that provide for some or all of the following rights:

• The right to subscribe for additional preferred shares when their securities convert in a next equity financing (referred to as Pre-Emptive Rights)
• The right to appoint a director or a board observer 
• The right to regularly receive financial statements or other information about the corporation's business (referred to as Information Rights).
• The right to receive the benefit of any more favourable terms given to other investors (referred to as Most Favoured Nation Rights)

Note that any side-letters like the ones outlined above are not included in our standard SAFE Financing service and are subject to additional fees.

What is the difference between a SAFE and a Convertible Note?

SAFEs and Convertible Notes are extremely similar investment instruments but there are some key differences. The most important difference is of course that SAFEs are not debt securities, meaning they are interest free and do not have maturity dates. This is advantageous to the founder(s) and startup, but is more risky for the investors.

What is a maturity date and why don’t SAFEs mature?

Maturity dates are a key feature of Convertible Note investments. Essentially, they are designed to protect the investor. At maturity, each note becomes due and payable on demand by the noteholder. When a startup that has issued convertible debt reaches the maturity date, the founders generally negotiate an extension with the noteholders, who may try to extract better terms in exchange for their consent to the extension of the maturity date.

SAFEs removed this staple of the Convertible Note to simplify the founder’s legal burden and otherwise streamline the deal making process. SAFEs do not have a maturity date or any requirement that the amount invested be returned to the SAFE holders at any point in the future (absent a sale or liquidation of the corporation). Until a conversion event occurs, the SAFE remains outstanding indefinitely. As a result, the SAFE lacks the maturity conversion feature that is commonly included in Convertible Notes.

SAFEs work best in situations where there is a strong level of institutional Venture Capital (VC) interest so that there is a reduced level of concern about closing a subsequent financing round and triggering a conversion event. 

Learn more about Convertible Notes.

What does Post-money and Pre-money mean?

The value of your company before you take on external investment is called the pre-money value. The post-money value is the pre-money value of your company, plus the amount of cash that was invested.

Before an investor puts money into your company, that investor owns 0% of the pre-money shares. After accepting external investment, your new investors own a percentage of the post-money shares. For example, if your company’s pre-money valuation is $2 million and you accept a $1 million investment, your investor purchased 1/3, or 33%, of your company, not 1/2. If the pre-money value of your company is $3 million, a $1 million investment buys 1/4, or 25%, of your company.

Post-money value = Pre-money value + Money invested

% investor owns = Money invested / Post-money value

The valuation cap in the Y-Combinator Canada SAFE is stated in terms of a post-money valuation (in contrast, the valuation cap in the NACO Canadian SAFE is based on a pre-money valuation). A post-money valuation and a pre-money valuation are just two different ways of framing the same valuation of the company, but at different points in time. 

In a way, the valuation cap embeds a share valuation in your SAFE Financing. The use of valuation caps came into practice for the benefit of investors once it became clear that if the company performed very well, it would negatively impact the total equity holdings of SAFE investors. 

Founders should be clear and explicit with their team and investors whether the valuation cap included in their SAFE investment contract is based on a pre-money valuation or post-money valuation.

Why does the Y-Combinator SAFE use a post-money valuation cap?

According to the Y-Combinator SAFE Quick Start Guide, the biggest advantage of the post-money SAFE is that the amount of ownership sold under the SAFE is immediately transparent and calculable for both the founder and the investor.  

The original Y-Combinator SAFE (and the current NACO Canadian SAFE) was standardized on a pre-money basis and inclusive of the Series A option pool increase, which made it difficult for founders to calculate precisely how they were being diluted when raising money.

Founders might have intended to sell around x% of their company but they didn’t have the best tools to accomplish this goal, which meant that they often ended up selling a lot more than they really wanted to, when they didn’t have to. The post-money SAFE helps founders better align their intentions with outcomes, because calculating dilution and ownership requires little more than simple addition and division. This simple calculation makes planning around those factors easier as well.

Y-Combinator offers the following example for raising money with a post-money valuation cap SAFE and calculating the amount of ownership sold:

A founder is targeting a $1 million SAFE Financing and 15% ownership sold to SAFE holders.

• Post-money valuation cap is $6.7 million ($1 million / 15% = ~$6.7 million). 
  
  •  “I’m targeting a $1 million SAFE Financing at $6.7 million post / $5.7 million pre. Post-money cap is $6.7 million.” 
• If the founder raises:
  • $500,000, then the ownership sold to SAFE holders would be 0.5/6.7 = ~7.5% 
  • $800,000, then the ownership sold to SAFE holders would be 0.8/6.7 = ~12% 
  • $1 million, then the ownership sold to SAFE holders would be 1/6.7 = ~15% 

Would it be better to just do a priced equity financing round?

As previously noted, the biggest advantage of the Y-Combinator post-money SAFE is that the amount of ownership sold to your SAFE investors is immediately transparent and calculable for both the founder and the investors. However, this also requires a company completing a SAFE Financing using the Y-Combinator post-money SAFE to complete a valuation exercise to establish an appropriate post-money valuation cap. 

With a valuation and pricing exercise required in both cases, the question of priced round versus SAFE Financing is more accurately reduced to what other rights an investor is looking for — e.g. board seats, investor veto rights, info rights, etc. that often come attached to a priced round — and whether those rights are important or appropriate for the fundraise being proposed.

How do I set a post-money valuation cap? 

Traditional valuation methods for established companies with stable cash flows (e.g. discounted cash flow, projections of future profits, asset value, book value) are totally inappropriate for valuing your company at an early-stage investment round. 

Valuations for startups at early-stage investment rounds must instead emphasize the value of a company's human capital, intellectual property, key reference accounts and solid strategic partners, and are generally the items that require most negotiation between founders and SAFE investors.

Here are some common methods by which experienced founders and angel investors determine and negotiate pre-money valuation ranges for early-stage investments in startup companies. 

1. Revenue multiple method

If your company has any revenues, you can establish a minimum valuation as a multiple of your revenue. 2–3X revenue is commonly accepted by angel investors for early-stage investment rounds. 

This method is commonly pushed by angel investors when evaluating an early-stage startup investment because it is easy to calculate and favourable to the investor. As a founder, however, you should be wary of this method since it assumes very low growth rates for your company and ascribes no value to the quality of your management team. Consider applying this method to determine the very bottom of your pre-money valuation range.

2. Market value method / Scorecard and risk factor summation methods 

Many angel investors argue that all interesting startups have essentially the same valuation at the very early growth stages (seed and pre-seed); typically, between $2.5 – 6 million. 

In many angel investors' eyes, your startup falls somewhere on this typical early-stage valuation spectrum depending on factors such as: 

• Strength of your business idea 
• Size of your market opportunity 
• Your prototype or MVP (Minimum Viable Product)
• Quality of your management team 
• Sales traction
• Strategic relationships 
• Value of your company’s Intellectual Property 
• Other investors on your capitalization table
• Other factors that might be unique to your startup

What if the pre-money valuation of the next financing round is higher than the SAFEs' post-money valuation cap?

The SAFE holder’s ownership will be the greater of (1) what’s implied by the post-money valuation cap, or (2) what could be purchased for the original amount invested under the SAFE (the Purchase Amount) at the price per share paid by the new money investors in the priced round.

In most situations where the pre-money valuation of the company in the next equity financing is higher than the post-money valuation cap, the post-money valuation cap will apply. In that case, the SAFE holder will be issued preferred equity, which has a liquidation preference equal to the Purchase Amount. This feature means that the liquidation preference for the SAFE holder does not exceed the original Purchase Amount of the SAFE (a 1x preference).

What if the pre-money valuation of the next financing round is lower than the SAFEs' post-money valuation cap?

As noted above, the SAFE provides that the SAFE holder gets the benefit of applying the post-money valuation cap or receiving shares of preferred equity at the same price per share paid by the new money investors, whichever results in a greater number of shares. 

When the pre-money valuation of the company in the next equity financing is lower than the post-money valuation cap, the SAFE holder will always receive a greater number of shares by using the price per share paid by the new money investors, and the post-money valuation cap will not apply.

Why am I limited in who I can take investment from for my SAFE Financing?

In Canada, securities laws state that any corporation, even a private issuer, must file and deliver a prospectus any time there is an issuance of securities (although not technically equity, SAFEs are deemed a security and, as such, SAFE Financings are subject to this rule under securities laws). However, private issuers are exempt from the prospectus filing requirements so long as they issue securities to certain categories of investors: 

1. Employees, officers, directors or consultants
   Exempt from the prospectus requirement so long as participation in the distribution in each case is voluntary and they have not been coerced into investing
2. Family and friends
   Friends and family are individuals who know the director, executive officer, founder or control person well enough and have known them for a sufficient period of time to be in a position to assess their capabilities and trustworthiness 
   1. The relationship between the individual and the director, executive officer, founder or control person must be direct. For example, the exemption is not available to a close personal friend of a close personal friend
   2. An individual does not qualify simply because the individual is a relative, a member of the same organization, association or religious group, or a client, customer, former client or former customer of the issuer
3. Close business associates
   Close business associates are individuals who have had sufficient prior business dealings with a director, executive officer, founder or control person of the issuer to be in a position to assess their capabilities and trustworthiness 
   1. The relationship between the individual and the director, executive officer, founder or control person must be direct. For example, the exemption is not available for a close business associate of a close business associate 
   2. An individual does not qualify simply because the individual is a client, customer, former client or former customer of the issuer
4. Accredited investors
   An accredited investor is an individual, entity, or financial institution that reaches certain financial thresholds that enable them to invest in certain opportunities that are not legally available to ordinary investors. If the investor does not fit the criteria of 1, 2, or 3 listed above, then they must be “accredited” by meeting 1 or more of the following criteria
   1. An individual who, alone or with a spouse, owns financial assets that exceed $1,000,000. Financial assets include cash and securities, but do not include a personal residence
   2. An individual who owns financial assets that exceed $5,000,000
   3. An individual whose net income before taxes exceeded $200,000 in each of the last two most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year
   4. An individual who, alone or with a spouse, has net assets of at least $5,000,000. Personal residences are included
   5. A person, other than an individual or investment fund, that has net assets of at least $5,000,000 as shown on its most recently prepared financial statements, where a "person" is defined as a corporation, trust, etc.
5. Persons, other than individuals, for an investment amount that is at least $150,000, where a “person” is defined as a corporation, trust, etc. and the investment is paid in cash at the time of trade

What is the difference between common and preferred shares?

Common shares are the most common form of ownership interest in a corporation. Common shares give their holders voting rights, the right to receive dividends when declared, and the right to a distribution of the corporation's assets on a liquidation or dissolution. Common shares do not have any special priority over your corporation’s assets. 

Preferred shares, on the other hand, give investors rights that the other shareholders in a company (like the founders and previous investors), don’t get. Primarily, they include a preference at the next round of fundraising or liquidity event like an acquisition or wind down. Other common preferred rights include things like special control rights, but there are many more rights that your investors might ask for. 

Holders of SAFEs do not typically receive contractual rights or protections above and beyond the ability to convert their securities into preferred equity. In order to enhance their rights or protections investors may negotiate side letters with the corporation that provide for preferential rights. Talk to your Good Lawyer if you wish to negotiate side letters for preferred investment terms with your SAFE investors. 

What materials should I have ready for Investors in my SAFE Financing?

It really depends on the sophistication of your investors and how far along you are, but here is a list of some materials that we suggest founders prepare when seeking investment.

1. Investor materials 
   1. Business Plan or Executive Business Summary
   2. Slide deck — see FAQ note below
2. Organized minute book, specifically
   1. Incorporation documents
   2. Share Register
   3. Capitalization Table
   4. Shareholder Agreement
3. Intellectual Property (IP)
   1. Documentation relating to your corporation’s critical copyrights, trademarks, patents or other intellectual property
   2. IP Assignment Agreements
   3. IP Licensing Agreements
4. Financials
   1. Historical financial statements, if any
   2. Budgets and forward-looking projections
   3. Any recent tax filings 
   4. Tax and payroll numbers from the Canada Revenue Agency
   5. Any grant related documentation
5. Team information
   1. Founder & employee contracts
   2. Team biographies and resumes
6. Business development
   1. Sales pipeline (AKA deals in progress)
   2. Sales deck and any other marketing collateral (i.e. case studies)
   3. Copies of any commercial contracts in place
7. Media
   1. Press clippings
   2. Links to online coverage and reports from third parties
8. Other: any other relevant information

Does the information that we share with investors create any legal risk or consequences for my company or leadership team?

Under Canadian securities laws, corporations that market and sell their securities with the assistance of slide decks, investor presentations and/or marketing materials may be liable for statutory penalties and direct damages payable to the purchasers of their securities where such materials contain a misrepresentation. This risk of liability is known under Canadian securities laws as the “Offering Memorandum” risk. 

In order to avoid the Offering Memorandum risk when sharing company documentation and/or marketing materials with prospective investors, some corporations carefully limit the information they deliver to prospective purchasers and choose to present or share investor presentations rather than leaving them with a prospective purchaser. 

If you are using slide decks, investor presentations, and/or marketing materials to help market your business to prospective purchasers, take extra care of the following:

• Ensure your materials do not contain false or misleading statements that could be expected to have a significant effect on the price or value of your company’s securities
• Limit use of and/or reliance on future-oriented financial information, unless you have a  reasonable basis for presenting such information
• Update previously disclosed forward-looking information that is no longer accurate
• Limit exaggerated reports and potentially misleading promotional commentary

Finally, corporations should always include a representation from the investor in the subscription agreement that they did not receive an Offering Memorandum or other offering document.

Nextblock Global Limited (Nextblock) and their executive team learned about the Offering Memorandum risk the hard way, in 2019. In a settlement with the Ontario Securities Commission over misleading statements in materials provided to potential investors, Nextblock and their CEO agreed to pay administrative penalties of more than $1,000,000, including $300,000 personally from the CEO. Nextblock’s investor deck wrongly stated that four people in the blockchain industry had agreed to be advisors to the company. 

The Nextblock case is a clear warning to founders that false statements in your slide deck can result in liability for both your company and your executive team and that the associated penalties may be severe.

If you’re unsure about the legal consequence of your investment materials, book a Legal Strategy Session with a Good Lawyer. 

Will my Good Lawyer negotiate with investors on my behalf?

No, your lawyer will draft the required documents based on the information provided about the business and the structure and economics of your SAFE Financing round. Your Good Lawyer will NOT negotiate on your behalf with any particular shareholder, founder, or investor. If requested, your lawyer will be happy to expand the scope of work relating to your SAFE Financing round to manage investor negotiations, investment mechanics and closing matters.

How should I think about dilution and future investment rounds?

Your company may require multiple rounds of financing before it grows sustainably. Each additional round of financing will reduce, or dilute, the ownership positions of founders and prior investors.

Here’s a simplified investment scenario to illustrate: 

Your angel investors purchase $500,000 of equity at a pre-money valuation of $1.5 million for 25% of your company ($2 million post-money). You successfully grow the company, validating your business model and generating revenue to justify a new pre-money value of $8 million. 

Your company is now seeking an additional round of investment to further accelerate growth. Let’s assume VC-A invests $2 million for 20% of the company. If the Founders do not co-invest, they will be diluted down from their original 75% to 60%. Here’s the math: 

Original Ownership Stake % (75%) x (1 – Stake of New Investors (0.20)) = Diluted Ownership Stake % (60%)].

When the company grows 3X to $30 million, it becomes eligible for a Series B financing. Again, the numbers work well if VC-B puts in $15 million for 33% of the company. This will dilute the founders down from 60% to ~40% [60% x (1 – 0.333) = ~40%]. 

See a summarized breakdown of this scenario in the table below.

	Seed	Series A	Series B
Pre-Money Valuation	$1.5 million	$8.0 million	$30.0 million
Angel Investment	$500,000	—	—
VC-A Investment	—	$2.0 million	—
VC-B Investment	—	—	$15.0 million
Post-Money Valuation	$2.0 million	$10.0 million	$45.0 million
Founder Ownership	75%	60%	~40%
Angel Ownership	25%	20%	~13%
VC-A Ownership	—	20%	~13%
VC-B Ownership	—	—	~33%

Are Shareholder Agreements legally required?

No, it is not a legal requirement that every corporation has a Shareholder Agreement in place. When raising early-stage investment capital with Goodlawyer, however, we recommend your corporation have a Shareholder Agreement in place to manage control matters among your new minority investors. Critically, your Shareholder Agreement should accommodate future minority investment and investors, while protecting the founders’ interests to efficiently manage the corporation’s operations. 

Learn more about Shareholder Agreements.

 

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