Startup and video game law, from a Canadian and U.S. perspective
SAFEs and the BC EBC Tax Credit
SAFEs (Simple Agreement for Future Equity) are used by early stage companies to raise investment without requiring the parties to determine the company’s value. Instead, future events determine the company’s value and prompt conversion of the SAFE into equity. As of March 2, 2019, SAFEs are now eligible for the British Columbia Eligible Business Corporation (EBC) tax credit, subject to certain requirements being met.
The EBC tax credit, in simple terms, is a 30% BC government tax credit received by investors for investments made in small businesses operating in qualifying industries in BC. In order for an investor to receive the tax credit: the company must be operating in a qualifying industry; registered for the EBC credit; the investment structure must qualify; and funds must be allotted and available to the company for issuance of the credit. Industries qualifying for the credit are quite broad and include: manufacturing; research and development of new technologies; destination tourism; digital media products; clean tech and advanced commercialization. BC also offers a similar tax credit for Venture Capital Corporations, which operates under the same overall program.
SAFEs typically contain clauses rendering them ineligible for the EBC tax credit and the BC government did not originally allow SAFEs to be used in tandem with the EBC tax credit. This posed a significant problem for small business that raised money with SAFEs.
While SAFEs are now eligible for the EBC tax credit, they need to be altered to remove clauses that make them ineligible. While the alterations required depend largely where the SAFE documents originate, be it from Y Combinator or a SAFE drafted by a Canadian law firm, clauses that need to be removed include:
- fixed term lengths of less than 5 years (admitted, more of a Convertible Note clause);
- repayment prior to 5 years from the date of investment;
- interest features (eligible SAFEs cannot operate as loans, again, more of a Convertible Note clause);
- assignment clauses (except in very limited circumstances); and
- liquidity and dissolution clauses that either allow for certain priority or preference over shareholders.
There are two ways to fix these issues:
- redraft the SAFE to make it compliant; or
- have each SAFE investor waive in perpetuity all rights that would make the SAFE ineligible.
The first approach is preferable as a wavier may cause unforeseen problems if the SAFE is not drafted with a wavier in mind and may inadvertently cause an investor to forgo important negotiated terms.
Nearly all of the SAFEs we review are ineligible for the EBC tax credit so investors should be wary if a company claims that their SAFE is EBC eligible. Furthermore, as EBC program funds can run out every year, we recommend planning ahead and making sure that all your documents are in order so the tax credit is not missed out on.