Regulation Crowdfunding platforms allow you to invest in startups using a variety of securities instruments. These can include stock, preferred stock, debt, revenue participation rights, SAFTs, Token DPAs and SAFEs. Each investment instrument has a unique set of pros and cons and may or may not be appropriate for a particular offering. Which instrument is most appropriate largely rests on the circumstances.
On Republic, the majority of companies make use of the Crowd Safe, a customizable version of the Y Combinator SAFE – designed specifically for securities crowdfunding offerings. Republic created the Crowd Safe instrument because existing instruments can be problematic when used by companies without a formal valuation, or where a priced round is impractical. These companies hope to one day become unicorns: achieving a major exit is the ultimate goal for a majority of the founders. These driven individuals are looking for a way to raise funds and engage their users, but don’t want to burden their operations.
The Crowd Safe is designed to be a win-win for both companies and investors, aligning the investor and company’ interests, however, as a gatekeeper, Republic monitors companies use of the Crowd Safe to protect investors from possible abuses.
The benefits of raising with the Crowd Safe
For companies to feel comfortable offering the right to equity to the crowd prior to an IPO, they need to have controls in place. Using the Crowd Safe gives the company the power to choose if and when its crowdfunding investors become shareholders or owners of record. The Crowd Safe is also extendable – unless the company goes public, has a change of control or is acquired a conversion is not forced, so companies can take in additional capital without incurring a messy cap table or giving investors rights that cannot yet be fully realized. Because companies raising with the Crowd Safe don’t have to deal with the burden of cap table management, they can pour more of their operational resources into developing their businesses, which can increase their odds of success and ultimately lead to upside returns for investors.
Another benefit of the Crowd Safe is the ability to ensure a fixed conversion price. If there is a conversion, this fixed conversion price ensures that investors have the same economic outcome, regardless of whether the Crowd Safe is converted to common stock or shadow shares. If a conversion occurs before an exit, due to the company wanting to add the investors to their cap-table, Investors receive unique shadow shares with limited voting and information rights upon conversion. These can have their economic rights tied to preferred stock issued later when the company is more mature but keep operation burdens down. Otherwise when investors are converted they can choose to receive common stock or be cashed out during an exit event.
The Crowd Safe also does not require setting or placing a formal valuation on the company. Through the use of the cap and discounts, companies can ensure investors have down side protection in the case that the company is sold for less than the valuation cap, but also an upside as they are treated as if they invested at the valuation cap if the company is sold above the valuation cap, meaning they will own a larger chunk of the company.
As the Crowd Safe sits dormant until a conversion event, generally, the issuing company does not have to provi de tax paperwork to the investor until that event, further reducing operational burdens.
When issuing common stock, companies can be left with hundreds of unaccredited investors on their cap table, each with a relatively small capital commitment, which can be problematic for several reasons:
For starters, company operations can become more complex with more shareholders who are entitled to certain information and voting rights. But with the Crowd Safe, information and rights are not provided by default to shareholders, until conversion. However, the Crowd Safe can also be used to incentivize large investments – clauses can grant investors who commit over a certain high threshold additional rights, meaning those investors (if accredited) won’t want to make a separate investment through a Reg D exemption, possibly muddying the cap-table further.
Another problem is that any company with 500 unaccredited shareholders and $10 million in assets falls under the SEC’s public reporting requirement, unless they meet certain requirements—the Crowd Safe makes meeting those requirements easier as it can leave investors in the Reg CF security longer, allowing a company that is (i) current in its reporting requirements and (ii) using a registered transfer agent to have up to $25 million in assets without needing to become a public reporting company.
So-called “problem investors” have limited impact when invested through a Crowd Safe, as their terms and rights are diminished, compared to common stockholders.
Having hundreds of unaccredited investors can also lead to a messy cap table, which can deter future institutional investment. Additionally, assigning valuations at an early stage, which is generally necessary when companies issue common stock, can be burdensome. The process is often costly and time-consuming, and this can hurt investors’ potential upside. Many in the industry are skeptical of placing a valuation on an early-stage company because the time and cost incurred in assigning one can sometimes amount to a mere educated guess.
Convertible notes often present many problems for both investors and companies and are difficult to manage for hundreds of investors. Convertible notes require lots of paperwork, have maturity dates, and accrue taxable interest. These issues are one reason raising with SAFEs has grown in popularity in recent years.
The Crowd Safe is admittedly an instrument meant for investors who are looking for a unicorn — a substantial return only comes about if there is a large exit. If the company never experiences that exit, the investment has limited value. But common stockholders are placed in the same position given equity holders’ gains are also tied to the success of a company, and minority stockholders have almost no ability to influence the course of an early stage private company.
Each investment opportunity is unique and using an appropriate instrument does not necessarily guarantee the viability of the investment. Republic thoroughly vets each company we host to ensure they meet our standards —- this includes evaluating whether the Crowd Safe is an appropriate instrument to raise with.
In the end, companies can be more likely to embrace securities crowdfunding when raising with the Crowd Safe given the multiple benefits. This furthers the democratization of fundraising as a whole, giving companies greater access to capital and investors greater investment opportunities.
See how the Crowd Safe works upon a liquidation event: https://crowdsafe.info/
To download Crowd Safe templates: https://republic.co/crowdsafe
Republic is a funding portal owned and operated by OpenDeal Inc., which is registered with the US Securities and Exchange Commission (SEC) as a funding portal (Portal) and is a member of the Financial Industry Regulatory Authority (FINRA). It is not a broker dealer or an investment adviser. Nothing on this article should be construed as legal advice, tax advice, accounting advice or advice to buy or sell securities. SEC registration does not constitute an endorsement by the SEC or FINRA and does not imply a level of skill or training. Investments in private companies are particularly risky and may result in total loss of invested capital. Past performance of a security or a company does not guarantee future results or returns.