Is a SAFE a security?

Yes. Despite the name ('Simple Agreement for Future Equity'), a SAFE is a security under federal and state law. It represents an investment contract where the investor provides capital with the expectation of receiving equity in the future. This means SAFE issuances must comply with securities registration requirements or qualify for an exemption such as Regulation D.

Do I need to verify accredited investor status?

It depends on the exemption you are using. Under Rule 506(b) of Regulation D, you can rely on investor self-certification through a questionnaire. Under Rule 506(c), which permits general solicitation, you must take reasonable steps to verify accredited status, such as reviewing tax returns, bank statements, or obtaining a letter from a licensed attorney, CPA, or broker-dealer.

What happens if I raise money without a securities exemption?

Raising capital without a valid securities registration or exemption is a serious violation. Investors gain rescission rights, meaning they can demand their money back plus interest. The SEC can pursue enforcement actions including fines and injunctions. State regulators can also bring actions. Officers and directors may face personal liability.

Can I raise from investors in other countries?

Yes, but additional legal considerations apply. Regulation S provides a safe harbor for offerings made outside the United States to non-U.S. persons. However, you must also consider the securities laws of each investor's home country, as many jurisdictions have their own registration and disclosure requirements. Anti-money laundering (AML) and know-your-customer (KYC) checks are also critical for international investors.

How do convertible notes convert?

At the next qualifying financing event (usually a priced equity round above a specified threshold), the outstanding principal plus accrued interest converts into equity. The conversion price is typically the lower of: (1) the valuation cap divided by the fully diluted share count, or (2) the price per share in the new round multiplied by the discount rate (commonly 15-25%). If the note reaches maturity without a qualifying event, the investor and company must negotiate -- options include repayment, extension, or conversion at a pre-agreed valuation.

What is phantom equity and when should I use it?

Phantom equity (also called shadow equity or synthetic equity) mimics stock ownership without issuing actual shares. The holder receives a cash payout based on the company's value at a triggering event such as acquisition or IPO. It is useful when you want to incentivize key employees or contractors without diluting actual ownership, complicating the cap table, or granting voting rights. It is particularly common in LLCs and companies whose exit strategy is acquisition rather than IPO.

Legal Issues in Fundraising for New Businesses

Interactive guide to 12 funding instruments, compliance checklists, and a decision tree to find the right fundraising approach for your startup.

Originally published April 16, 2023 · Updated March 2026 · By Sergei Tokmakov, Esq.

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