Thanks for starting this topic, @andrew. I think it’s extremely helpful to learn from the mistakes of others in the hopes of not repeating the same mistakes!
Similar to you, most of my investments are going pretty much as one would expect (given that most are still far too early to expect any type of significant exit).
The one negative outcome (that may not seem to be negative) was in a SAFE investment that had “repurchase rights”.
Repurchase rights (sometimes also referred to as a redemptive clause, I believe) basically give the issuing company the option to buyback all the crowdfunding investors at the issuing company’s discretion (although each set of deal terms likely has differences).
One thing to note: I have even seen repurchase rights on Common Stock and equity on some platforms, so it isn’t necessarily a SAFE that is the issue in this case, but having the repurchase clause.
In the case of this company I invested in, I knew going in that the SAFE had repurchase rights and had highlighted that as a potential risk. However, I decided to move forward for two reasons:
- I still really liked the company, and the “downside” of a company exercising their repurchase right means that you’d still likely get at least your original amount invested back, and
- The repurchase rights would be at the greater of either A) The Fair Market Value of the security, or B) The original investment amount.
In the case of 2, I figured that the “Fair Market Value” would mean that if my company was doing really well, while I’d miss any potential upside after the repurchase, I’d at least get a good return up until then.
Well, it kind of played out as anticipated. On paper (and in my opinion), this company was probably one of my best performing and future potential investments that I had made. However, shortly after COVID hit in 2020 (which wouldn’t have negatively impacted, and may have even drastically helped, this company’s business model) - they decided to exercise the repurchase.
So I held the SAFE for ~11 months and made 1.5X my money. Great, right!? Not quite.
As I mentioned, while I did technically make a gain, I still believe this was one of my highest potential investments.
What’s even worse is that the “1.5X” return is far, far less than I feel the true valuation of the company was worth at the time. While they claimed to have done a “Fair Market Value” assessment with a third party, I honestly think they timed it during COVID to coincide with a massive temporary (and non-real) drop in many other valuations, so they effectively got a much cheaper paper valuation than the company was worth.
As you know, it’s often the very, very small minority of investments in a startup portfolio that generate most of the returns. So it’s absolutely CRUCIAL that when you do get that one investment, the company doesn’t buy you out.
I probably won’t be investing in any more repurchase rights deals in the future. Although I don’t really see them much (if at all) anymore, so I wonder if platforms are strongly discouraging issuers from issuing securities with these terms since they are so unfriendly to investors.