The Securities and Exchange Commission is monitoring a troubling trend arising out of its Regulation Crowdfunding – the use of a new startup-financing instrument, the so-called “SAFE,” in offerings that are intended for a broad, mostly retail base of investors, SEC Commissioner Michael Piwowar said Tuesday.

Speaking at the North American Securities Administrators Association’s and SEC annual Section 19(d) Conference, (held just before NASAA’s annual public policy conference), Piwowar stated that SAFE, which stands for a “simple agreement for future equity,” is an agreement “between an investor and a company in which the company generally promises to give the investor a future equity stake in the company if certain triggering events occur.”

While these SAFE securities have been used in some Reg CF offerings, “they are not securities with which many retail investors are well acquainted,” Piwowar said.

“An investor only receives an equity stake in a SAFE company if the specific terms of the security are met. If the terms are not met, the investor is left with nothing.”

As an additional element of risk, he continued, “the terms governing whether and when an investor may receive the future equity vary from offering to offering. In short, despite its name, a so-called SAFE is neither ‘simple’ nor ‘safe.’”

To help educate investors about the potential risks associated with SAFE offerings, the SEC’s Office of Investor Education and Advocacy released the same day an investor bulletin regarding these instruments.

The alert stated, in part, that themost important thing to realize about SAFEs is that you are not getting an equity stake in return. SAFEs are not common stock. Common stock represents an ownership stake in a company and entitles you to certain rights under state corporate law and federal securities law.  A SAFE, on the other hand, is an agreement to provide you a future equity stake based on the amount you invested if — and only if — a triggering event occurs. SAFEs do not represent a current equity stake in the company in which you are investing.  Instead, the terms of the SAFE have to be met in order for you to receive your equity stake.” 

SAFEs “were first developed in Silicon Valley as a way for venture capital investors to invest quickly in a hot startup without burdening the startup with the more intense negotiations that an equity offering usually entails,” Piwowar added.  

For some venture capital investors, “the value of obtaining an opportunity for a potential future equity stake exceeds that of protecting a relatively small investment in a SAFE,” he continued. “The terms of the SAFE, from the triggering events to the conversion terms, are typically designed to operate in the context of a fast-growing startup likely to need and attract future capital from sophisticated venture capital investors.”

Piwowar noted the information sharing agreement that the SEC and NASAA signed in February to improve “our ability to assess whether these new capital formation options are serving their intended purpose.”

— Check out SEC Boosts How Much Firms Can Raise via Crowdfunding on ThinkAdvisor.