1. Summary - our recommendation

The Danish Companies Act does not provide for a SAFE as an investment tool. A SAFE therefore does not have any validity under company law, but must instead be categorized as an ordinary civil law agreement. It is therefore only binding on the parties that have entered into a SAFE (and thus typically not the company's shareholders). A SAFE therefore presents some significant challenges, which means that Danish lawyers should rarely recommend using SAFEs. For investors, there is no guarantee that the investment will actually be converted into shares. For the company, this can have significant tax consequences. In addition, the "investment amount" does not accrue to the company's equity, but constitutes a debt obligation that unnecessarily affects the company's liabilities (thus making the company less attractive to potential debtors and other investors) and which an investor may risk demanding repayment.

As an alternative to SAFEs, you should instead recommend using a warrant or a convertible debt instrument.

Warrants should be used when:

• the company's valuation can be determined in advance,
• an exercise price can be specified for the shares (typically at par),
• the investor will inject additional funds through the acquisition of shares upon exercise; and
• when the portion of the share capital that the investor can subscribe for can be agreed upon, but the investor does not have to be a shareholder when entering into the warrant.

Convertible debt instruments should be used when:

• investors pay the investment amount immediately, but the valuation of the company is determined during a later actual investment round,
• A bridge financing is carried out, i.e. the terms of the investment are negotiated by a (lead) investor in a later investment round,
• a discount(Discount Cap) is desired on a future valuation as compensation for the early investment, possibly combined with a cap on the valuation(Cap), and
• the company can bear the debt obligation that the debt instrument entails.

If you nevertheless choose to use a SAFE - for example, because the investor is foreign and does not want to deal with investment tools that are subject to Danish law - it is recommended that not only the company, but also all shareholders join the SAFE. This ensures to a greater extent that shareholders during a general meeting are obliged to endorse the conversion of the SAFE into shares.

2. What is a safe?

A Simple Agreement for Future Equity (SAFE) is an investment agreement invented in Silicon Valley that gives investors the right to subscribe for equity in a company at a later date, typically at a future investment round where the company's valuation is also determined. It's a quick way to raise venture capital without having to negotiate legal transaction documents, which can often be a time-consuming (and expensive) process. The investment amount is paid immediately, but the subscription of shares takes place later.

Danish law does not operate with SAFEs or instruments that can be compared 1:1 with them. The problem arises because there is no consideration (shares or warrants) in connection with the payment of the investment amount, so it can hardly be argued that the investment amount is added to equity. Therefore, in the absence of alternatives, the investment amount will be categorized as a debt (receivable) to a SAFE investor, which in a later investment round converts this debt into equity. a later investment round converts this debt into equity. However, this is a process that is incompatible with the Company Act's procedures for debt conversions, unless the conversion is approved at a general meeting.

A SAFE gives the investor the right to convert their SAFE investment into equity in the company under certain conditions, such as a future investment round(Equity Financing) or an exit event, a valuation event (like an IPO) or an exit event. In other words, the investor is guaranteed conversion to equity at a later date. Danish law does not provide the same possibility for the same guarantee for SAFEs.

SAFEs are characterized by being a simple and flexible method to raise capital quickly and with minimal legal costs for startups in their early funding stages. A SAFE is typically a standardized investment document that contains few terms and rights, eliminating negotiation and administration. In practice, you fill in a few fields in the standardized document, sign and transfer money. However, a SAFE contains some important terms to be aware of:

• Post-Money Valuation: If the parties can agree on a valuation, it can be entered into SAFEn. This ensures that the investor is aware of their ownership share in the company in connection with the latest issue of shares.
• Discount Rate: If the parties cannot agree on a valuation or choose to postpone it altogether, it can be beneficial to agree on a discount rate on the valuation set on the last investment round. In this way, the investor is compensated for the extra risk associated with the early investment. The discount rate is typically between 15-30%.
• Valuation Cap: There may be cases where the parties find it necessary to agree on an upper cap on the valuation of the later investment round. This is typically to protect the investor from excessive dilution and/or that the later investment round is carried out at such a much later date that the investor is not properly compensated for the risk associated with its early investment.
• Liquidation Preference: There is a risk that the company between the SAFE investment and the later investment round goes bankrupt or is dissolved(Liquidity Event or Dissolution Event). During this period, the investor has no rights, includingLiquidation Preference, as is often the case when investors subscribe for preference shares with preferential rights. Therefore, it is often seen that a liquidation preference is agreed in a SAFE, which is a civil law agreement on a liquidation hierarchy where the investor has priority over other shareholders, typically the company's existing shareholders by the proceeds that may be available in connection with a bankruptcy. a bankruptcy.

A SAFE is thus a convenient way for early investors and startups to enter into quick and flexible investment agreements without significant costs. However, as mentioned, there are legal challenges associated with the use of SAFEs under Danish law and the Danish Companies Act.

3. Challenges with safe under Danish law

As mentioned, the Companies Act does not provide for a SAFE or any other instrument that is 1:1 comparable to a SAFE. Therefore, there are legal risks and potential conflicts associated with using a SAFE anyway:

1. Civil law agreement: Entering into SAFEs is considered a civil law agreement between the parties and does not automatically provide corporate law protection for the investors, unlike convertible debt instruments and warrants where investors are guaranteed the subsequent conversion or subscription into newly issued shares. This means that an investor entering into a SAFE may find it difficult to enforce its civil law claim that the company must issue the agreed shares. As a SAFE is typically entered into with the company - and thus not the company's shareholders - it does not bind the shareholders, who may risk refusing to approve the general meeting resolution where the new shares are to be issued. This may cause investors and companies to be reluctant to enter into a SAFE, as it may be difficult to predict how Danish courts will treat such agreements in case of disputes.

2. Valuation requirements: The Companies Act requires that a valuation of the company is determined when shares are issued. This is because the minimum and maximum amount of shares to be issued must be stated. The Companies Act contains fixed procedures for (other) investment instruments such as warrants and convertible bonds, which SAFEs do not comply with. SAFEs typically do not set a valuation at the time of entering into the agreement, but defer this to a future conversion event.

3. Pre-emptive rights: The Companies Act contains a pre-emptive right for existing shareholders to subscribe for new shares in proportion to their ownership interest in capital increases. A SAFE may conflict with these pre-emptive rights as it gives SAFE investors the right to subscribe for shares at a later date without taking into account the pre-emptive rights of existing shareholders.

4. accounting and auditing requirements: Danish law contains detailed accounting and auditing requirements for companies. A SAFE may create ambiguity as to how the investment should be recognized in the company's accounts. The investment amount can hardly have been added to the company's equity. Although the circumstances probably speak in favor of treating the investment amount as a liability, there is no accounting practice in this regard.

5. Tax consequences: Under Danish law, tax is payable on gains from the sale of equity investments and dividends. As a SAFE is not an equity share (but should entitle to equity shares), it may be unclear how the tax rules should be interpreted in connection with the conversion of a SAFE into equity shares and how any gains and dividends should be taxed. This can create uncertainty and potential tax consequences for both investors and companies.

These challenges make it necessary for Danish companies and investors to consider alternative investment structures that comply with Danish law and company law, such as convertible debt instruments and warrants.

4. How do you overcome these challenges and what alternative ways are there to structure an investment?

A SAFE is an efficient and non-expensive instrument that combines "the best of both worlds" for venture capitalists looking to invest in early-stage companies. The company receives access to capital immediately and without necessarily engaging advisors, and investors can defer the negotiation of commercial and legal terms while still obtaining the necessary legal protection.

Convertible debt instruments and warrants are two financial instruments that can be used as alternatives to SAFEs when investing in Danish startups. Both instruments are compliant with the Danish Companies Act and offer similar advantages to SAFEs. In contrast to SAFEs, which under Danish law merely constitute a civil law agreement, for which there are no statutory content requirements, the Danish Companies Act contains content requirements for both convertible debt instruments and warrants. It can therefore be argued that there is less flexibility associated with convertible debt instruments and warrants compared to SAFEs.

Convertible promissory note

A convertible debt instrument is a regular debt instrument with the addition that the loan amount can be converted into equity against the issuance of shares in the company. A convertible note is a loan given by an investor to a company with the option to convert the loan into equity in the company at a later date, usually under certain conditions or events (e.g. a future investment round).

The advantages of using convertible bonds as an investment instrument are as follows:

1. Legal recognition: Convertible debt instruments are a recognized form of investment in Danish law and company law, creating clarity and legal certainty for both investors and companies.

2. Fixed interest rate: Since convertible debentures are loans, the company pays a fixed interest rate to the investors until the loan is converted into equity. This gives the investors a certain gain even if the conversion to equity does not happen. It can also be agreed that the interest is added to the principal so that it can be converted into more shares later.

3. Flexibility: Convertible debt instruments can be adapted to different investment strategies and risk profiles as the terms of conversion and interest payments can be negotiated between the parties.

4. Valuation cap: It is possible to insert an upper limit to the valuation. A valuation cap is introduced in convertible debt instruments to protect investors from potential excessive dilution of their equity stake when the debt instruments are converted into equity. The valuation cap is a tool that can be used to reduce risk for investors and make convertible notes more attractive as investment instruments, especially for early investors in startups where there is great uncertainty about the future valuation of the company.

The disadvantages of using convertible bonds as an investment instrument are as follows:

1. Debt obligation: As convertible debt instruments constitute loans, it imposes a debt obligation on the company, which affects the company's liabilities and thus increases the company's insolvency risk and makes the company less attractive to other debtors.

2. Creditor: Since a convertible debt instrument is a receivable, the lender is considered a creditor rather than an investor. It is only when the creditor chooses to convert its loan that it becomes an investor. It is at the creditor's discretion to choose whether they want to have their debt repaid (possibly with interest added) or whether they want to "take the plunge" and convert their debt into equity. In other words, the creditor can "go either way" and the company does not know whether it is "bought or sold" until the creditor has decided whether to convert or not. This uncertainty is an advantage for the investor and a disadvantage for the company.

3. Complexity: Convertible debt instruments can be more complex than SAFEs as they contain more terms and rights to be negotiated and managed.

Warrants

A warrant is a subscription right that gives investors the right, but not the obligation, to subscribe for shares in a company at a certain price (exercise price) within a certain time period. Warrants are not only a tool granted to employees as part of their remuneration. Warrants can also be used for investments, where investors can subscribe for shares when the company completes an investment round or achieves certain milestones.

The advantages of using warrants as an investment instrument are as follows:

1. Legal recognition: Warrants are recognized in Danish law and the Danish Companies Act, which provides legal clarity and security for both investors and companies.

2. Potential gain: Warrants allow investors to get an upside of the company's value increases without necessarily having to subscribe to the shares.

3. Protection against dilution: Since warrants give investors a right, but not an obligation, to subscribe for shares in the company, they can be used as a form of protection against dilution of the investment. Investors may choose to exercise their warrants to maintain their ownership stake via their pre-emptive rights if the company issues more shares in the future.

4. Attracting investors: Warrants can be an attractive investment option for investors as they often have limited downside risk. If the market price of the shares falls and never exceeds the exercise price within the warrant's validity period, the investor only loses the amount they may have paid for the warrants and not the full value of the shares they could have subscribed for. This limited loss can make warrants more attractive to investors seeking higher returns with limited risk. This can make it easier for startups to attract capital and fund their growth.

5. Less influence on corporate governance: Since warrants do not give investors voting rights until they are converted into equity shares, companies can continue to make decisions without immediate influence from warrant investors. This can give company management more flexibility and control over the company's strategy and operations.

The disadvantages of using warrants as an investment instrument are as follows:

1. Time limit: Warrants usually have an expiration date, which means that the investor must exercise them within a certain time period. If this does not happen, the warrants lose their value and the investor misses the opportunity to subscribe for the shares.

2. Exercise price: Warrants have a fixed exercise price that the investor must pay to convert the warrants into shares. Therefore, a price must be set for the shares at the time of issuing the warrants.

3. Complexity: Warrants can be complex instruments that require management and monitoring by both investors and the company. This can lead to increased costs and resource consumption in connection with the administration and handling of warrants.

In summary, convertible debt instruments and warrants can be more administratively burdensome than SAFEs and have certain disadvantages. However, they are instruments whose validity is regulated by Danish law and thus provide clarity to the investor and company regarding the subsequent process. Unlike SAFEs, the Danish Companies Act contains clear substantive requirements for both instruments, and there is a fixed procedure for their adoption and procedure for any conversion.

5. Conclusion

Danish startups face legal challenges when it comes to SAFEs under Danish law and the Danish Companies Act. To overcome these challenges, alternative investment instruments, such as convertible debt instruments and warrants, may be more appropriate. These legally recognized instruments can offer investors attractive return opportunities while limiting downside risk. By making the correct choice of investment instrument, it is possible for both startups and investors to navigate the complex legal landscape and establish a solid foundation for successful investment and future growth.

At Samar Law, we are dedicated to providing legal support to both investors and start-ups in the early investment stages. We take pride in staying updated on the latest developments in the start-up industry.

If you have any questions or need advice, you are welcome to contact lawyer Payam Samarghandi via email at payam@samarlaw.dk or by phone on +45 60 79 37 37 77.

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