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The Simple Agreement for Future Equity (“SAFE”) investment vehicle, first introduced by the Y Combinator in 2013, is most often used by early-stage companies to raise money ahead of a priced round of financing. While the SAFE vehicle was originally conceived as “a simple and fast way to get that first money into the company,” as the SAFE has grown in popularity, it has also evolved and expanded into what the Y Combinator describes as “wholly separate financings, rather than ‘bridges’ into later priced rounds.”&nbsp;This evolution, along with developments in foreign investment screening mechanisms, means that using the SAFE vehicle for investments from foreign sources requires consideration of potential interest from the Committee on Foreign Investment in the United States (“CFIUS”). When a U.S. company receives SAFE funding from a foreign investor, even though certain terms may be subject to future valuations, the investment may still be subject to CFIUS jurisdiction. Dismissing CFIUS jurisdiction considerations for SAFE transactions involving foreign investors may present greater risk than is sometimes recognized.&nbsp;

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The SAFE agreement, while neither a debt, per se, nor a current equity investment, per se, is a convertible instrument. As described below, the SAFE converts to equity upon the occurrence of a specifically identified event or events, and thus is not a current equity investment. It differs from a convertible note because it generally does not include payments described as “interest,” nor a set maturity date. Nonetheless, it is definitely a “Contingent Equity Interest” as that term is defined in the CFIUS regulations: “a financial instrument that currently does not constitute an equity interest but is convertible into, or provides the right to acquire, an equity interest upon the occurrence of a contingency or defined event.” 31 C.F.R. § 800.207.

CFIUS has the authority to determine both that it has jurisdiction and whether it will treat contingent rights as converted for purposes of deciding its jurisdiction. As a result, the exact nature of the contingent rights in a SAFE investment will be important to determine whether the transaction is subject to CFIUS jurisdiction at the time the SAFE is issued and whether CFIUS decides to exercise that jurisdiction.&nbsp;

Although parties tend to view contingent rights as prospective, if CFIUS concludes that the contingent rights should be viewed as converted, the implications could be significant. For example, if the U.S. business qualifies as a TID U.S. Business (31 C.F.R. § 800.248), then getting the assessment wrong means the investment may have been subject to the CFIUS mandatory filing requirement. Even if the mandatory filing requirement is not applicable, SAFE investments could still be subject to CFIUS review as a contingent investment.

Moreover, while SAFE investments are touted as less complex, where they include side letters or other collateral agreements, those terms can also impact whether the transaction must or should be put before CFIUS. Therefore, it behooves investors and U.S. businesses to ensure that those terms do not include rights that could lead to CFIUS jurisdiction when converted, such as board membership or observer rights, governance rights, or access to material non-public technical information.

As foreign investment in early-stage companies continues to grow,<a href="#_ftn1">[1]</a> both the companies and the investors should be wary of assertions that CFIUS is not a consideration simply because the funding is undertaken through the SAFE investment vehicle. CFIUS’ approach to contingent interests counsels investors to ensure that a robust analysis of agreements, side letters, or other documents in a transaction occurs to address any potential mandatory filing requirements in connection with a SAFE financing. In addition, where a specific contingent interest does not trigger a mandatory filing, an analysis of the nature of the interest, the technology, infrastructure or data involved, and the likelihood of a national security interest should be conducted to manage the potential for CFIUS outreach through its non-notified process team.

The SAFE investment vehicle was developed by the Y Combinator, an accelerator focused on early-stage companies, as an alternative to convertible note investments.&nbsp;The SAFE agreement is a convertible security, but unlike debt instruments, SAFEs do not accrue interest or have a maturity date. This makes them an attractive fundraising option for early-stage startups that lack the infrastructure to negotiate complex note terms and that seek to benefit from the greater certainty provided by a SAFE. Although not debt, the SAFE converts into equity upon the occurrence of certain specified events, usually a later financing round or a liquidation event.&nbsp;

SAFEs are often attractive to early-stage companies and to companies seeking to raise capital with a faster execution timeline. The SAFE approach also provides a company with other benefits, including:

a longer timeline to achieve target milestones before a priced equity round;

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a greater level of control prior to the conversion of the SAFE into equity;

rolling closings, which allow a faster close with each investor;

reducing the likelihood that one investor drives the financing process; and

fewer closing costs and expenses because there are fewer terms to negotiate than in an equity financing.

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From the investor side, the SAFE provides a means to reach a mutually beneficial valuation target, though a valuation cap, based on the company’s ability to raise funds in the future.&nbsp;Because a SAFE has no expiration or maturity date, there is normally no need to spend time dealing with extending maturity dates, revising interest rates or the like.

When a SAFE is used, the contract represents the entire agreement, and there is, therefore, no immediate issuance of equity or debt. As a result, there is no immediate equity dilution, and because it is not a loan, a SAFE does not typically accrue interest or have a maturity date. The lack of accruing interest can be important to the balance sheet.

Most SAFEs include the following standard terms (though some investors may use their own version of the Y Combinator agreements):

the conditions under which the investment converts to equity;

valuation cap, which reflects the maximum valuation of the company upon conversion;

the discount rate, which reflects an investor’s reduced conversion price per share compared to later investors;

treatment of the SAFE investment in the event of a change of control or sale of the company; and

participation rights for future investment rounds.

The Y Combinator SAFE alsoaddresses when and how conversion of the SAFE into equity will occur. These provisions, in particular, play an important role in any CFIUS jurisdictional review. More specifically, the conversion of SAFEs will depend upon specific trigger events. The most typical triggers are:

Later equity financing. When the company raises its next priced round, the SAFE converts into shares at the valuation cap or discount.

A liquidity event. If the company is sold or goes public before raising another equity round, the SAFE typically either converts into equity that will receive payment as part of the liquidity event, or cash, usually whichever is greater.

In addition to the immediate rights, SAFEs are likely to provide investors with the implied future rights that will accompany a future financing round of the company. Thus, when the company ultimately raises its next round, if the investors at that time negotiate additional rights, such as board nomination rights, information rights, anti-dilution protection, pro-rata participation rights in future financing rounds, or rights of first refusal on certain stockholder transfers, the SAFE investor(s) will also obtain those rights if they are invested/converted at an amount that triggers them.

Although these rights typically do not accompany the SAFE investment itself, investors can be fairly confident that these rights, in some form, will be granted to them, especially if the next round is preferred stock. Given that the contours of preferred stock financings are fairly similar and often include customary and well-known investor rights, a SAFE investor (especially experienced investors) would be well aware of the types of future rights that will likely be granted in the company’s next financing round when the SAFE converts into equity.&nbsp;

CFIUS is a multi-agency panel that reviews investments (or acquisitions) by foreign persons (whether individuals or entities) in U.S. businesses to ensure that the investment does not present a national security concern. While the national security remit defines CFIUS, the scope of its review extends into anything that CFIUS (or the President and federal agency members of CFIUS) has determined may constitute a national security threat. Threats can include investments by non-U.S. parties in companies involved with critical technology, critical infrastructure, or large amounts of U.S. citizens sensitive personal data, for which filings may be mandatory. However, even if not mandatory, CFIUS has jurisdiction to review transactions that impact other national security concerns, including supply chain resilience and security, U.S. technological leadership, and impact on future advancements. CFIUS also retains jurisdiction to determine whether it has the authority to review a transaction—in essence, jurisdiction to determine whether it has jurisdiction over the deal.&nbsp;

CFIUS has been directed, through&nbsp;<a href="https://www.govinfo.gov/content/pkg/FR-2022-09-20/pdf/2022-20450.pdf">Executive Order 14083</a> (“EO 14083”), to focus special attention on the impacts and potential impacts arising from foreign acquisitions and investments in a number of technology areas, including: “microelectronics, artificial intelligence, biotechnology and biomanufacturing, quantum computing, advanced clean energy (such as battery storage and hydrogen), climate adaptation technologies, critical materials (such as lithium and rare earth elements), [and] elements of the agriculture industrial base that have implications for food security.” This list represents the current view of where critical technology concerns arise and EO 14083 leaves open the possibility to focus on additional technology sectors, depending upon the role other sectors could play in supporting U.S. national security interests.&nbsp;

Where CFIUS filings are mandatory, parties must submit the filing at least 30 days prior to “completing” their transaction, and the parties may not proceed with their transaction until CFIUS issues a decision. If CFIUS determines the transaction to be of concern or potential concern, it can require further filings and issue a standstill order until it completes its analysis. Ultimately, if the transaction raises serious national security concerns, CFIUS can require mitigation (often in the form of restrictions on access to technology, limitations on governance rights, or physical facility restrictions) or, where a mitigation agreement cannot be reached, recommend that the President block the transaction.

CFIUS has jurisdiction to review (1) transactions that result in foreign “control” of a U.S. business, and (2) transactions in which a foreign investor obtains board or observer rights, access to certain “material nonpublic technical information,” or involvement in certain “substantive decision making” with respect to a “TID U.S. Business” (such transactions, together with (1), “covered transactions”).&nbsp; A TID U.S. Business is one that:

produces, designs, tests, manufactures, fabricates, or develops one or more “critical technologies”;

performs certain functions with regard to “critical infrastructure”; or

maintains or collects, directly or indirectly, certain “sensitive personal data” of U.S. citizens.

CFIUS jurisdiction applies both pre- and post-transaction. That is, if a mandatory filing is required, parties must submit a transaction for CFIUS review before the transaction is completed. If no mandatory filing is required, the parties may submit their transaction for review either before or after completion. If CFIUS reviews a transaction and determines that there are no national security concerns, or resolves those concerns through mitigation, then its jurisdiction ends (absent false statements or omission of material information during the CFIUS review). However, if a transaction is not submitted for review, CFIUS may request a submission, or undertake a unilateral review if parties refuse the request, and it retains the full range of authorities to order mitigation or divestiture in order to address U.S. national security concerns. This authority to review such “non-notified” transactions is not subject to any statute of limitations.

Application to Contingent Transactions

CFIUS jurisdiction arises at the point there is a “transaction,” “whether proposed or completed,” which can include any form of acquisition, merger, joint venture, investment, or conversion of a contingent equity interest. 31 C.F.R. § 800.249. While somewhat awkwardly worded, the definition includes “proposed” conversions of equity interests as within CFIUS’ remit. CFIUS has further clarified its interpretation of these rules with respect to convertible interests in two important ways:

In section 800.308 of the CFIUS regulations (31 C.F.R. § 800.308), CFIUS provides timing rules for contingent transactions, and reserves to itself the determination whether to include “the rights that a holder of a contingent equity interest will acquire upon conversion of, or exercise of a right provided by, that interest.” The rule provides several factors CFIUS will consider when making this determination, including:

the imminence of conversion or satisfaction of contingent conditions;

Under section 800.308, then, CFIUS can treat “contingent equity interests” as actual equity interests using these factors, and any other factors it deems relevant (the provision refers to this list in terms that make clear it is non-exclusive).

Separate from section 800.308, CFIUS has addressed so-called “springing rights.” The springing rights approach was developed as a way to minimize or eliminate the need for a mandatory filing for certain transactions that involve “TID U.S. Businesses.”&nbsp;

Specifically, there can be a mandatory filing where (1) certain sovereign investors engage in a “covered transaction” in a “TID U.S. Business,” or (2) where a TID U.S. Business designs, fabricates, develops, tests, produces, or manufactures certain “critical technologies,” and a U.S. export license would be required to export the company’s technology to the foreign investor engaging in the covered transaction.

Transactional lawyers reasoned that they could, therefore, effectively divide a transaction into two parts, albeit with one agreement, and not run afoul of the mandatory filing requirement. Specifically, they would have the non-controlling equity portion of an investment take effect immediately upon closing, and provide for rights within section 211(b) contingent&nbsp;upon CFIUS approval. In certain instances, a change of view might lead to abandonment of those rights if no CFIUS review was sought.

In this manner, the rights that give rise to a mandatory filing “spring” only upon receipt of CFIUS approval. In many instances, this was not an attempt to hide transactions from CFIUS purview. Rather, it was an effort to complete the transaction, which might be time-sensitive, without the requirement for a potentially lengthy CFIUS review. The investor would have to be content with a passive equity investment if, for example, CFIUS decided that the additional rights raised national security issues.

Among the many dilemmas for CFIUS created by this approach was what to do about the allegedly passive investment, over which CFIUS arguably lacked any jurisdiction. To address this question, CFIUS ultimately concluded that transactions that included springing rights were, in fact, one single transaction, and therefore became subject to the mandatory filing provisions.

Where a mandatory filing is required, the parties must make the filing at least thirty days before the “completion date.” 31 C.F.R. § 800.401(g). Parties using springing rights reasoned that there were two completion dates—one for the passive equity investment; and a later completion date for the springing rights that created mandatory CFIUS jurisdiction. CFIUS disagreed.&nbsp;

In a response to a “Frequently Asked Question” (FAQ),<a href="#_ftn2">[2]</a> CFIUS clarified that the “completion date” for purposes of determining whether a mandatory filing should be made when a transaction includes investor springing rights is “the earliest date upon which any ownership interest is conveyed, assigned, delivered, or otherwise transferred to a person.”&nbsp;

Further, addressing specifically the concept of springing rights in contingent arrangements, CFIUS advised that:

In a transaction where the ownership interest is conveyed before the foreign person receives the corresponding rights, the ‘completion date’ is the earliest date upon which the foreign person acquired any of the equity interest.&nbsp;

To further address any potential for ambiguity, CFIUS provided an example:&nbsp; “if Company A acquired a 25 percent ownership interest in Company B on July 1, but its right to control Company B was deferred until after CFIUS reviews the transaction, the “completion date” for the transaction is July 1.”&nbsp;

Importantly, CFIUS distinguished between springing governance&nbsp;or control&nbsp;rights and situations where the equity interest itself is contingent: “Note that contingent equity interests are assessed separately under 31 C.F.R. § 800.207.” That section provides a definition of “contingent equity interest” as “a financial instrument that currently does not constitute an equity interest but is convertible into, or provides the right to acquire, an equity interest upon the occurrence of a contingency or defined event.”

Therefore, depending upon the exact nature of the SAFE investment agreements and any side agreements, CFIUS jurisdiction, whether mandatory or voluntary, may attach as early as the date the SAFE investment is made; and if the U.S. business is a TID U.S. Business, the SAFE investment may be subject to mandatory filing rules at least 30 days before closing of the SAFE financing. Given that CFIUS may, depending on the rights conveyed/contingent, construe the contingent portion as effective as of the issuance of the SAFE, any other rights may either be immediately involved or subject to the springing rights rule.

CFIUS has the ability to determine both that it has jurisdiction and whether it will treat contingent rights as converted for purposes of that analysis. As a result, the exact nature of the contingent rights in a SAFE investment will be important to a determination whether the transaction is subject to CFIUS jurisdiction at the time the SAFE is issued and whether CFIUS decides to exercise that jurisdiction.&nbsp;

If CFIUS concludes that the contingent rights should be viewed as converted, the implications for failing to take CFIUS into consideration could be significant. For example, if the U.S. business qualifies as a TID U.S. Business (31 C.F.R. § 800.248), getting the analysis wrong, or neglecting to even consider CFIUS, means the investment may have been subject to the mandatory filing requirement. Failing to obtain CFIUS clearance for a mandatory transaction can have serious repercussions, including the assessment of monetary penalties equivalent to the transaction value. Even if the mandatory filing requirement is not applicable, if a SAFE investments is subject to CFIUS review, it can impact the transaction in significant ways, including:

The company could be put through a long, expensive process (called the non-notified process) where CFIUS seeks information about the parties and the transaction. That process can last months or years, placing a potential cloud for new investors.

If CFIUS has national security concerns, it can compel the foreign investor to divest its interest, even its contingent interest.

CFIUS can require that the company put in place mitigation measures, such as limits on access, limits on rights afforded the investor, or similar. These measures can be particularly problematic if the standard SAFE terms are used because those terms do not take CFIUS into account.

SAFE investments, while touted as less complex and costly, may still be accompanied by side letters, and other collateral agreements. Therefore, it behooves investors and U.S. businesses to ensure that those terms do not include either springing rights—ones that occur automatically upon satisfaction of a CFIUS filing (other than a subsequent financing)—or rights that could lead to CFIUS jurisdiction when converted, such as board membership or observer rights, governance rights, or access to material non-public technical information.

If the SAFE investment involves the SAFE investor’s participation in later funding rounds, and the initial round is not submitted for CFIUS review, then CFIUS can review the entire later as either single or multiple transactions. This could have implications for the first equity round. For example, if that round does not include foreign investors, needing a CFIUS review because of a converting SAFE investor can cause problems in that later round.

CFIUS’ approach to contingent interests counsels investors to ensure that a robust analysis of agreements, side letters, or other documents in a transaction occurs to address any potential mandatory filing requirements in connection with a SAFE financing. In addition, an analysis of the nature of the interest, the technology, infrastructure, or data involved, and the likelihood of a national security interest should be conducted to manage the potential for a CFIUS outreach through its non-notified process team.&nbsp;

With increased emphasis on enforcement and specific CFIUS admonitions that it pays close attention to structures that seek to avoid CFIUS jurisdiction, the use of SAFEs where there are foreign investors may be subject to heightened CFIUS scrutiny. As a result, when using the SAFE structure, parties should consider including provisions that address the CFIUS impact that might occur at the later equity round as well.

For more information or assistance, please contact <a href="/people/kenneth-j-nunnenkamp/" type="poa_person" id="18271">Kenneth J. Nunnenkamp</a>, or another member of Blank Rome’s <a href="/services-and-industries/international-trade/" type="poa_practice" id="18498">International Trade</a> group.

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<a href="#_ftnref1">[1]</a> A Federal Reserve Note from December 31, 2024, describes as a “salient feature” of U.S. entrepreneurship “the growing extent of foreign venture investments in Silicon Valley, particularly from Chinese corporations, individuals, and financial institutions, . . . often in critical areas, such as artificial intelligence, fintech, robotics, and virtual reality.” Ufuk Akcigit, et al. <a href="https://www.federalreserve.gov/econres/notes/feds-notes/cross-border-venture-capital-and-reverse-technology-flows-20241231.html">Cross-border venture capital and reverse technology flows</a>.&nbsp;

<a href="#_ftnref2">[2]</a> FAQs are a preferred administrative agency device that eliminates the need for full and formal rulemaking under the Administrative Procedures Act. While they are non-binding, they are often viewed as expressions of agency interpretation and/or of agency enforcement positions.&nbsp;

Is Your SAFE Transaction Safe from CFIUS?

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Is Your SAFE Transaction Safe from CFIUS?

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