I created the Simple Agreement for Future Equity (SAFE) for LLCs for my LLC clients who needed a simple financing instrument to raise capital swiftly and efficiently, while retaining pass-through tax treatment for their businesses. The SAFE for LLCs is an alternative to the Y Combinator SAFE, which is designed specifically for C-Corporations.
With the passage of the Tax Cuts and Jobs Act of 2017, the LLC remains a very favorable structure for business entities, the owners of which may now be eligible to deduct 20% of their LLC-derived “qualified business income” on their individual tax returns (subject to certain exceptions and limitations).
Since the LLC is largely a creature of agreement, its inherent flexibility allows the SAFE for LLCs to be tailored to a wide variety of financing transactions. This post showcases two case studies of those LLC financings:
- The Search Fund Financing:
- Background: A former business executive at a multinational corporation partnered with two individuals with complimentary backgrounds to raise a search fund to acquire and roll-up various retail business assets under an LLC holding company. The assets were to be consolidated, updated and re-branded, thereby adding substantial value.
- Challenge: The client needed to quickly raise approximately $500,000 to finance the asset search, due diligence,and initial asset payments. From their contacts in the industry, the client team had access to capital from private accredited investors, but needed a vehicle to receive and deploy the funds.
- Solution: I created a variant of the SAFE for LLCs called a “Seed Financing Investment Agreement (SFIA)” that allowed the client to raise the capital and spend it over 6-month search period (extendable for another 6 months) to identify and secure assets for possible acquisition in accordance with its business plan. Upon the closing of a “next equity financing” (e.g., financing of at least $3,000,000) or a “liquidity event” (e.g., sale of equity or assets of the LLC), each SFIA will automatically convert into the SFIA investor’s pro rata portion (based on his/her investment amount) of 25% of the the equity units owned by or issued to the LLC founders in the acquisition entity as of the closing. This structure, coupled with the founders’ experience and acumen, clearly aligned the investors’ and founders’ interests, and the target $500,000 was raised in short order. After the issuance of all SFIAs, the LLC closed the “next equity financing” for the acquisition and roll-up of the target assets and the SFIAs converted to founder-equivalent equity.
- The Film Financing:
- Background: A film production company sought to raise capital for a new documentary film involving a time sensitive and controversial matter. The funds would be used to identify a screenwriter, develop a script, and engage in related film development activities.
- Challenge: The client, a special purpose LLC wholly-owned by the film production company, needed to raise approximately $300,000 to finance the initial development of the project.
- Solution: I created a variant of the SAFE for LLCs called a “Film Development Investment Agreement (FDIA)” that allowed the client to raise sufficient capital to finance the project within 30-60 days. The FDIAs will automatically convert into a special class of equity units upon the closing by the LLC of a “next equity financing” for the consummation of the project. The equity units to be issued to FDIA investors offer a superior return to the equity units anticipated to be issued to investors in the “next equity financing”, including the right to receive a priority return of capital plus a preferred return on the FDIA investor’s investment amount. If a “liquidity event” occurs before the “next equity financing”, each FDIA investor had the priority right (over the LLC owners) to receive his/her original investment amount plus 30% of such amount, reduced on a pro rata basis among investors based on the LLCs available cash. The LLC is currently using the FDIA funds to carry out development of the film.
These two case studies are merely two examples of the many ways in which LLCs can swiftly and efficiently raise capital using the SAFE for LLCs.