How to adapt a YC post-money SAFE for a UK investment

Y Combinator, perhaps the world’s most prestigious startup accelerator, first introduced the original simple agreement for future equity – or ‘SAFE’ – in 2013, as an alternative to convertible loan note instruments.  In 2018, YC introduced the ‘post-money’ SAFE to allow for greater predictability as to equity dilution: under the post-money version, each investor’s ownership percentage is easier to calculate at the time of investment, removing the inherent ambiguity as to percentage ownership and dilution where the price is otherwise left to flex until conversion.

Copies of the instrument are available on the YC website, and there are variations for a SAFE with a valuation cap but no discount, a discount but no cap, and a version with neither but with a most favoured nation clause that will apply the most favourable cap and/or discount terms offered to other investors in the round.

Even though the governing law and jurisdiction clause is left blank in the YC drafts, the language used throughout is very much aimed at US companies and the framework of US corporate law generally. They can, however, be adapted for UK investee companies and English law.  Some key issues to consider are as follows.

Governing law and jurisdiction

The blank governing law and jurisdiction clause would usually be completed with English law and submission to the jurisdiction of the English courts.  This is not a cosmetic change – the choice of governing law affects how every provision of the agreement is to be interpreted and enforced.  English courts apply well-developed principles of contractual construction, but they differ from, for instance, Californian courts in material respects: in particular as regards implied terms, the introduction of external evidence, the approach to good faith, and so on.

Stock, shares and corporate terminology

The SAFE uses US corporate law terminology throughout – ‘stock’, ‘common stock’, ‘preferred stock’, ‘purchasers of stock’, etc – none of which maps directly onto UK company law.  References to ‘stock’ should be replaced throughout with ‘shares’, which in respect of a UK company are to be ‘issued and allotted’ on conversion rather than ‘purchased’ or ‘sold’.

Change of control

The YC SAFE includes conversion provisions to be triggered by a ‘Liquidity Event’, defined as a “Change of Control, a Direct Listing or an Initial Public Offering”.  Some of the terminology used within those terms has no direct UK equivalent, and careful thought should be given as to whether the terms should be adapted to track on to the equivalent UK-style exit terminology.  And when it comes to an IPO, the issuer may well look to the US but presumably the London Stock Exchange and AIM should be considered for inclusion in the definition.

Company representations should change to warranties

The SAFE contains “representations” to be made by the issuer to the investors, but the term does not have exactly the same meaning under US and English law.  Crucially, under English law, misrepresentation is a tort and comes with the remedy of rescission, which involves unwinding the contract to return the parties to their original positions.  Breach of warranty, on the other hand, comes with a remedy for damages if losses can be proved, causation shown, remoteness tests satisfied, and so on.  For a UK issuer raising funds under an English-law-governed SAFE, the ‘reps’ should change to warranties.

Investor representations, financial promotions and AML/KYC

The SAFE also includes representations made by the investors to the issuing company.  If the investors are resident in the US, the parties may be content to leave these as drafted.  If the investors are UK resident, then they are likely not “accredited” under the US Securities Act of 1933 and the provisions ought to be amended.

A prudent UK issuer will have considered section 21 of UK’s Financial Services and Markets Act 2000 and sought to find applicable exemptions for the investors lest it fall foul of the UK’s own financial promotion regime.  Wording should be considered to cover the point, although the more important point is to be comfortable that there is in fact an available exemption for each investor – for instance, a self-certified sophisticated investor, high net worth individual, or professional investor.

EIS and SEIS

If the investors are hoping to take advantage of the UK’s Enterprise Investment Scheme or the Seed Enterprise Investment Scheme (providing them with significant income tax and capital gains tax reliefs), the SAFE is likely not the correct starting point.

Equity-only ‘convertibles’ can be made to work for those tax reliefs, but – among other considerations – conversion is expected by HMRC to take place within the six months that follow.  A SAFE could be adapted to make that work, but the parties are typically better off starting with a UK-style advance subscription agreement designed to work for EIS and SEIS investments.

Corporate authorities

Under the UK’s Companies Act 2006, the directors of the issuing company will in the context of a convertible need to have authority from the shareholders in order to allot shares or to grant rights to subscribe for, or to convert any security into, shares.  Before the SAFE can be signed, an ordinary resolution of the shareholders is required to provide that authority.

There are pre-emption rights on issue set out in the Companies Act 2006.  These might have been dis-applied by way of a provision in the issuing company’s articles of association to make way for a bespoke regime for pre-emption.  Either way, unless the statutory rights were disapplied and no bespoke regime was adopted in their place, pre-emption rights need to be dis-applied by the shareholders by means of a special resolution or waivers.

The directors would typically circulate those resolutions to the shareholders, and – with the authority in place and pre-emption rights dis-applied – the board should convene to clear any conflicts of interest, consider their statutory obligations generally, and all else being well resolve to have the SAFE signed on behalf of the company.  Board minutes ought to be produced to record that decision making process.

Are SAFEs equity or debt or both or neither?

From the investee company’s point of view, if the valuation metrics have been properly considered, SAFEs remain an attractive means of raising finance. They are thought to be equity rather than debt instruments for US purposes, principally because there is no obligation to repay the sums invested in lieu of issuing stock to the investor. In the UK the position is much the same and they are analogous in structure to an advance subscription agreement, although we are not aware at time of writing of the position having been addressed here by a Court and treatment may differ for company law, tax, accounting and insolvency purposes

Investors should be aware, however, that until the shares have been issued the investor does not have the usual rights of an equity holder – no voting rights, no dividend entitlement, no right to participate in a rights issue – and holds only those more limited equity-like rights set out in the SAFE itself. There is also no right to a return of the capital invested other than on a subsequent sale of the shares, or in the limited dissolution mechanics provided for in the instrument. SAFEs can sit on the cap table for a long time before converting, and the terms on conversion should be modelled carefully before signing.

As ever with matters of corporate finance, prudent investors and issuing companies take advice before signing contracts and transferring or accepting funds.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

Humphreys Law