As we highlight in our recent blog post, we have seen a rise in the use of simple agreements for future equity (“SAFEs”) in the private equity market.
While SAFEs can be a great way to usher money in the door quickly, a notable pitfall for prospective investors is that once the SAFE is converted into equity – even if it occurs the next day – the shares that they would receive upon conversion of the SAFE are currently ineligible under Manitoba’s Small Business Venture Capital Tax Credit Program (the “Program”).
One of the key functions of a SAFE is that each SAFE holder is entitled to have that SAFE convert into equity at a discounted rate (such as 10% to 30% discount) or at a capped valuation to incentivize their early funding of that company. For prospective investors of a company that is eligible under the Program, a discount is not as attractive if you lose out on a 45% tax credit. Ideally, prospective investors would want both.
In the interest of encouraging prospective investors to fund Manitoba small businesses, this blog post makes a case for why SAFEs could be included in the Program.
What is a SAFE?
A SAFE is an agreement between an investor and a company whereby the investor agrees to give the company funds for the right to either automatically acquire equity securities of a company at a future date in connection with a future equity financing of that company or be paid out in cash if a liquidity event occurs prior to the occurrence of any equity financing.
What is the Program?
The Program is a tax credit program in Manitoba that, subject to certain conditions, allows an investor to receive a 45% non-refundable tax credit for investments in eligible shares of an eligible small business in the province. For more details about the Program and how it works, please see our previous blog post or the Program website.
Why are SAFEs currently excluded under the Program?
Only “equity shares” are eligible to be issued under the Program. According to the regulations for the Program, with the exception of shares that are issued in connection with the exercise of stock options, shares issued in connection with the conversion of any other convertible security do not qualify as “equity shares” under the Program. For the holders of SAFEs, which are convertible securities, this is problematic.
Reasons SAFEs could be included in the Program
The following are three reasons why SAFEs could be included in the Program:
ONE. A SAFE is intended to automatically be converted into equity shares, usually during the next equity financing. Accordingly, there is a case that they should be afforded similar treatment as equity shares under the Program.
TWO. Both British Columbia and Saskatchewan currently allow SAFEs under their respective venture capital tax credit programs.
Under B.C.’s venture capital tax credit program, which include similar restrictions on eligible shares, SAFEs qualify as “eligible shares” provided that the SAFE is an “at risk investment,” has a five-year hold period that transfers to the conversion shares, does not accrue interest or include any security assignment feature.
Under Saskatchewan’s venture capital tax credit program, SAFEs are permitted with a three-year hold period that transfers to the conversion shares.
These examples show how other provinces have broken ground and set precedents in Canada for successfully integrating SAFEs into venture tax credit programs.
THREE. There are functional solutions available to address the policy challenges that exist around including SAFEs in the Program:
- The funds that are received by the company in connection with a SAFE offering could be required to flow through a law firm, as is currently required for the issuance of eligible equity shares. That law firm could then be required to send a reporting letter to the Program upon completion of the SAFE offering and again when the SAFEs are converted into eligible shares of the company under the Program.
- The funds that are received by the company could be required to be used for eligible purposes only under the Program.
- The required three-year hold period for eligible shares of the company under the Program could commence when the SAFE is converted or have a longer hold period, as is the case in B.C.
We encourage the Government of Manitoba to consider allowing SAFEs under the Program. Doing so could give Manitoba small businesses more financing flexibility and incentivize investors to use SAFEs as investment vehicles.
If you have any questions with respect to SAFEs or the Program, please contact Kyle Mirecki in our Winnipeg office.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.
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