US Investment into the UK: Getting SAFEs and ASAs Right

When a SAFE is used by a UK company, the nomenclature will have to be adapted to reflect UK terminology in order to work in practice. For example, the standard Y-Combinator SAFE prevalent in the US refers to basic shares as “common stock,” whereas in the UK, these are called “ordinary shares”. And, in the US, investors typically expect to receive “preferred stock” in consideration for their SAFE investment as compared to the UK where investors would receive “preference shares” (but may have the expectation of receiving only ordinary shares). In addition, certain of the standard definitions used in SAFEs, such as “Initial Public Offering”, “Direct Listing” and “Change of Control” will require amendment to ensure they capture UK-law offerings and exits. If such changes are not made, disconnects may occur down the line when the SAFE converts.

Since ASAs are designed for use by UK companies, the terminology does not require similar adaptation.

In order to comply with UK corporate law, the conversion mechanics in a SAFE will require amendment for use by a UK company. In typical early-stage investment transactions, US investors will seek equity in the form of preferred stock which carries with it preferential rights, including upon an exit or liquidity event. The rationale behind this preference is to reward the investor for taking the risk of an investment in an unproven business with equity that carries rights, preferences and privileges beyond those afforded to “plain vanilla” common stock, which is typically reserved for issuance to founders, employees and other service providers in the US. However, in the UK, prior to undertaking a priced equity funding round, a typical company will only have immediate authority to issue ordinary shares, and therefore, a special resolution would be required to create a new share class. Therefore, the SAFE will need to be adapted to state that it will convert into shares carrying the rights existing under the company’s articles at the time of conversion instead of specifying with certainty that the SAFE will convert into preference shares to be authorised later, as is typical in the US.

In the UK, all shareholders are statutorily entitled to pre-emptive rights which allows them to take up more shares as a company continues to issue equity in order to ensure their ownership percentage is not diluted by later issuances. In the US, pre-emption is not a statutory right but is a contractual right that investors would typically expect to receive in exchange for their investment and that is often included in convertible securities such as a SAFE. When investing through a SAFE, US investors will typically expect to these contractual pre-emptive rights that will allow them to invest in a later funding round, typically up to a pro rata percentage which takes convertibles like ASAs and SAFEs into account. Since these investors do not hold actual shares, however, these rights conflict with the statutory pre-emption rights held by existing shareholders in a UK company, which might need to be disapplied to permit entry into these contractual pre-emptive rights.

UK companies must also consider US securities law implications when issuing ASAs or SAFEs to US investors. Although the issuer is incorporated in the UK, offers and sales into the US to US investors must comply with US federal and state securities laws. As a result, appropriate investment warranties and transfer restrictions must be incorporated into ASAs to make them suitable for use with US investors. (Note this is not an issue with the standard Y-Combinator SAFE which already includes these provisions.)

Finally, one of the most important considerations when a UK company issues a SAFE is ensuring that the SAFE does not resemble a debt instrument. If a SAFE resembles debt, this may create concerns under UK tax rules or insolvency law. This issue is particularly important where the company intends to preserve eligibility for SEIS or EIS tax relief. A SAFE that is not adapted may jeopardise such reliefs if it provides excessive downside risk protection or offers redemption rights. To avoid this risk, UK-adapted SAFEs are typically revised so that an investor’s funds are treated as non-refundable advance payments for future shares. Insolvency provisions are also commonly modified to ensure the investor does not rank as a conventional creditor.

The considerations discussed above are examples of some of the key areas of divergence that can exist when US investors seek to make investments in the UK using either typical UK or US early-stage investment vehicles. As US investment into the UK becomes more prevalent, the investment ecosystem in the UK will need to become more adaptable to US investors. SAFEs and ASAs can be practical investment tools for these cross-border investments when both UK and US corporate legal concepts are aligned within the documentation. At MBM, our US attorneys are uniquely placed on the ground in the UK within the investment market with experience on both sides of these transactions.