Jaakko Lindgren, Senior Associate, Castrén & Snellman Attorneys Ltd.

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2. Introduction
• Jaakko Lindgren
• Senior Associate, Castrén & Snellman Attorneys Ltd
• Various legal issues relating information technology
• Legal Counsel, Tieto Corporation 2009-2013
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3. Facts
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6. Hybrid Instruments in Startup Financing
Convertible notes and SAFE
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7. www.arcticstartup.com
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8. Hybrid instruments
• Balancing risks and profits
• Differ from pure equity or debt instruments e.g. in
their
• Distribution and control rights
• Payment priorities
• Liquidation and dilution preferences
• Permanent
• Conflicts between different fields of law
• E.g. corporate law, tax law, accounting
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9. Covertible note – main features
• Loan, which can be converted into company shares
• Conversion launched by a set of events or maturity date
• Creditor’s receivable is set off against the subscription
price
• Treated as debt in accounting until conversion
• Accrues interest
• Pre-determined valuation – conversion ratio
decided, when entering into contract
• Usually conversion ratio = principal of the loan /
conversion ratio at the moment of issuing the note
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10. Background for developing SAFE
• YCombinator has been a forerunner in promoting
the use of convertible notes in startup financing
• Aim to lower the transaction costs
• Simplicity as a target
• The mechanisms and options are actually variable
• SAFE was created to address certain problems
with convertible notes, such as:
• Maturity date (creating a threat of insolvency)
• Accrued interests (complicated calculations)
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11. Main features of SAFE
• Actually a further structured convertible note
• Includes a liquiditation preference structure
• Main differences compared to a traditional
convertible note:
• Conversion launched by only circumstances, not by
a maturity date
• No accruing interest
• Appreciation of stock price controlled with a
valuation cap or discount rate
• Permanent investment?
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12. Conversion of SAFE
• Conversion into a special class of preferred
shares, ”SAFE Preferred shares”
• Conversion is launched in case of:
• Equity Financing
• Liquidity Event
• Change of Control or IPO
• Dissolution Event
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13. Example calculations
Investor has purchased a SAFE for $100,000. The Valuation Cap is $5,000,000.
The company negotiates with investors to sell $1,000,000 worth of Series A Preferred Stock
at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock
immediately prior to the financing, including a 1,000,000 share option pool to be adopted in
connection with the financing, is 11,000,000.
The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the
new investors. The company will issue and sell 220,022 shares of Series A-1 Preferred to the
SAFE holder, at $0.4545 per share.
In the SAFE, the Series A Preferred is referred to as “Standard Preferred Stock” and the Series
A-1 Preferred is referred to as “SAFE Preferred Stock.” The table below sets forth a comparison
between the Standard Preferred and the SAFE Preferred, as each would be described in the
company’s certificate of incorporation:
Standard Preferred Stock
SAFE Preferred Stock
Liquidation preference on a
per share basis:
$0.90
$0.4545
Aggregate payout in a
change of control transaction
(each series pari passu with
the other):
$1,000,000
$100,000
Conversion price and original
$0.90
issuance price at the time of (initially converts into 1,100,110
the Series A Preferred fishares of common stock)
nancing:
Dividend Rate per share
(based on an 8% dividend):
$0.072
$0.4545
(initially converts into 220,022
shares of common stock)
$0.036
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14. Example calculations
• Investor has purchased a SAFE for $100,000. The
Valuation Cap is $7,000,000.
• The company grows, generates revenue and
becomes cash flow positive, and therefore does not
need to raise outside capital. The company has no
acquisition offers and no plans to go public.
• The SAFE will remain outstanding until the
company has a liquidity event, even if that liquidity
event doesn’t happen for years after the original
date of purchase.
• Or it never happens?
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15. Example calculations
• Example 8
• Investor has purchased a SAFE for $20,000. The
Discount Rate is 80%.
• The company has negotiated with investors to sell
$400,000 worth of Series AA Preferred Stock at a
$2,000,000 pre-money valuation. The company’s
fully-diluted outstanding capital stock immediately
prior to the financing is 10,500,000.
• The company will issue and sell 2,105,263 shares of
Series AA Preferred at $0.19 per share to the new
investors. The 20% discount applied to the per share
price of the Series AA Preferred is $0.152. Accordingly,
the company will issue 131,578 shares of Series AA-1
Preferred to the SAFE holder, at $0.152 per share.
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16. The Finnish Companies Act in relation
to convertible notes and SAFE
• Both convertible notes and SAFE are ”special
rights entitling to shares” according to the FCA
• Issuing special rights requires ”a weighty financial
reason”
• The General Meeting can decide on issuing special
rights or authorize the board to decide on the
issuance
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17. FCA chapter 10 section 3
A decision concerning the issue of option rights
or other rights referred to in section 1 shall
contain the following information:
for payment for the shares;
•
•
(1) the shares to which each option
right or other right referred to in
section 1 pertains, as well as whether new
or treasury shares are to be issued;
•
(2) the number or maximum number
of option rights or other rights referred to in •
section 1 to be issued;
•
(3) who has the right to receive or to
subscribe for option rights or other rights
referred to in section 1;
•
(4) if the option rights or other rights
referred to in section 1 are to be issued
against consideration, their subscription
prices or other consideration for them, the
subscription period and the deadline for
payment;
•
(6) justification for the existence of the
weighty financial reason for the issue of the
rights, as referred to in section 1(1), as well
as justification for the determination of the
subscription price or the other consideration
for the rights and of the subscription price of
the shares; and
(5) the subscription prices,
subscription period and the deadline
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(7) the status of the rights in a share issue, in
the issue of rights under this chapter in
accordance with some other decision, in the
distribution of company assets in
accordance with chapter 13, section 1(1), in
the reacquisition of rights under this
chapter, in the merger of the company into
another company, in the demerger of the
company and in the redemption of minority
shares in accordance with chapter 18.
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18. The Finnish Companies Act in relation
to convertible notes and SAFE
• Need for multiple share classes (FCA 3:1) in case of
SAFE
• Share class description in the articles of association
needed
Basically description according to the SAFE –agreement.
However, if the concepts within the agreement are not
well established in Finland, there is a problem in defining
them  impact on transaction costs
• Probably still interpreted as convertible note according to
FCA
• Price of the SAFE -instrument credited into debt account
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19. SAFE Summary
•
Transaction costs are not as low as promoted
• Possibly high transaction costs of implementing necessary measures to
comply with FCA, because
• Number of scenarios under the instruments is high
• Definitions in the articles of association and in the decisions made by
the shareholders and the board must cover the scenarios
•
•
If executed, registration issues with the Finnish trade register
Not recommended for small investments due to the possibly high
transaction costs
• If the compliance with the FCA provisions can be ”standardized” this might
change
•
Altough promoted as ”simple” and including only ”few” issues to
negotiate, requires expertise to understand the effects of those few
negotiable parameters
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20. In conclusion
• Hybrid instruments are recommendable form of
financing for startups
• However, especially in case of small investments,
high rate of standardization is needed in order to
keep transaction costs low
• Standardization is not just a matter of the contract
between the investor and the company
• GM decisions, articles of association,
registrations
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21. Thank you!
Jaakko Lindgren
Senior Associate
Master of Laws
Phone +358 (0)20 7765 444
Fax +358 (0)20 7761 444
jaakko.lindgren@castren.fi
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