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Home Forums Startup Investors Offering Questions and Discussion SAFE + Revenue Share Reply To: SAFE + Revenue Share

  • Brian

    November 5, 2020 at 9:20 pm

    Hi Kevin,

    You’re in the right place!

    If you haven’t read the article and watched the video already, here’s a good place to start to get an overview of the types of financial securities that are offered in equity crowdfunding:

    That being said, the Fig gaming shares being sold on Republic are relatively new and I didn’t cover them.

    Quick disclaimer: I briefly went through the Subscription Agreement and Offering Circular, but I could have easily missed important points, so take all this with a grain of salt and just as some initial thoughts (not legal/professional/tax/investing advice)

    Question 1 – Revenue Share agreements

    It is a little confusing the way that the Fig Gaming shares in Amico on Republic are structured. That’s because the security you are buying looks like it is technically “non-voting Preferred Stock“, but that stock is tied to the licensing agreement (and as you mention, revenue share) that Fig has with Amico; so it differs from the typical expectations of “Preferred Stock” when you invest in a company through a SAFE. So you’ll really be getting paid dividends entitled to you from your preferred stock.

    Definitely read the entire Offering Circular, as painful as it may be. In particular, you may find the Dividend Formula on pages 4-5 useful, as well as Licensing Agreement details starting on page 39, since it outlines the terms of the revenue sharing agreement. It also documents important details like risks, fees, etc. I usually use Find (CTRL+F) and find key terms throughout the document (e.g. “fees”, “license agreement”, “dividend formula”, “valuation”, “risks”, etc.)

    In terms of revenue share agreements, you’ll tend to see these with food & beverage companies, main street brick and mortar businesses, and businesses/products that build up to a big “launch” and then expect royalties – think things like games, movies, albums, etc.

    I tend to stay away from revenue share deals, but that doesn’t mean they can’t be profitable for investors. My main reason for shying away from these deals is that most revenue-share agreements have a capped upside.

    For example, if you read the terms, it may say that revenues will be shared at x% over a certain time period, until 2X (or 3X, or whatever the multiple is) is paid back.

    For my own personal investment goals, I’m looking to place bets that have a capped downside (i.e. I can’t lose more than I invested) but an unlimited upside potential. And unfortunately, the majority of the revenue share deals I’ve seen don’t allow that.

    So the risk profile is different. There might be less overall risk because the game is likely to net at least some revenue and not go to zero (although it still could); however, the tradeoff is that you’re capping the upside on your potential return. It just depends on your personal investment style, goals, risk aversion, etc.

    I might have some more time to read the Offering Circular some more later this weekend and can add some more thoughts.

    Question 2 – SAFEs

    SAFEs tend to divide investors into two camps. Some investors, including the creator of the SAFE, Y-Combinator, truly believe that the SAFE is a simple document for investors and founders, and by being simple (and not imposing a “debt” aspect of an interest rate like a Convertible Note has), gives the founder and the startup the most time possible to successfully bring their product to market and get to the next milestone.

    That being said, they have been abused in the past, and terms can wildly differ form the Y-C standard, so it’s important to understand the type of SAFE you’re investing in.

    And to that point, it isn’t only SAFEs that have been abused. Convertible Notes can suffer the same bad terms, and I’ve even seen Common Stock on some of the platforms that have “repurchase rights”, which is something that most investors should stay away from as it again caps your potential upside (without removing any of the downside risk).

    TopTal was a famous example of a company that screwed over some big name VCs (Andreessen Horowitz, etc.), and investors on a Convertible Note (I believe) that never converted to equity, so you can only do so much, and it goes to show that even the absolute best investors sometimes get burned. That’s why diversification is so important.

    Things to watch out for in SAFEs are:

    • What’s the valuation cap and discount rate? Do they sufficiently compensate the earliest investors for the risk you’re taking?
    • Are there “repurchase rights” or a “redemptive clause”? Basically, can the company choose to buy out the investors by repurchasing shares whenever they want? If so, think about why they included that – it limits your upside potential and would likely only be exercised if the company was doing well (and while investors would get a “small” win, it’s not the type of return angel investors need in a startup portfolio).
    • What are the situations that the SAFE converts? SAFEs on Wefunder vs. Republic are quite different, as some of them will convert at the next eligible financing round (e.g. Series A may trigger conversion), while others may not convert unless there is an acquisition or IPO. There are pros/cons of when it converts to equity. For example, if you’re looking to take advantage of Section 1202 100% tax-free gains, the 5-year holding period for that typically won’t start until you have actual equity ownership in the company. On the other hand, it actually can be beneficial from a dilution perspective if your SAFE ends up converting later rather than sooner.
    • Does it convert to Common or Preferred shares? This isn’t a huge deal, but can be good to know in advance.

    In the end, it again comes down to an investor’s goals and personal preferences and beliefs. Personally, I invest in a lot of SAFEs, Convertible Notes, and Common/Preferred Stock. No matter the security, I ensure that I know the terms, and for SAFEs and Convertible Notes, I try to understand how it will convert.

    Hope this helps! And sorry for the long response….

    Part 4 – Deal Types in Equity Crowdfunding