Who thought politics would form part of an investment instrument? Used in international economic relations and international politics, the ‘Most Favoured Nation’ (“MFN“) clause is predominantly used to ensure non-discriminatory treatment between members. It is used by the World Trade Organisation as well as the United Nations to manage country relations and promote equal trade.
Although it would seem odd to find such wording in an investment instrument, especially where it relates to equity investments into private companies, it is a term often and predominantly found in a SAFE instrument, being the acronym for ‘Simple Agreement for Future Equity’.
Once you wrap your head around the meaning and use behind the clause though, it seems to oddly, yet elegantly fit, almost like pineapple on a pizza (my apologies for the sacrilegious statement, my Italian friends, Davide and Cristiana).
Before we can come to grips with the use of the MFN clause, we need to first understand the SAFE instrument. This document is used by investors to purchase the right to subscribe for preferred shares in an investee company, upon the next round of equity funding. In this manner, the company is capitalised, and the investor gets his foot in the door, so as to acquire preferred shares at a later stage.
The benefit of this document for the investor is that it allows them to invest in a company quickly and effortlessly and without having to negotiate terms of the preferred shares (as this comes at a later stage, namely the next round of funding). It also allows an investor to secure some skin in the game at a time when the valuation of the company is uncertain, as the company will be valued at the next round of funding.
Additional benefits for the investor include the introduction of discounts or valuation caps, in terms of which they could receive slightly more shares at the next round of funding than they would have, had they invested at the next round of funding. The motive for this is that they took on risk by investing at an early stage and therefore deserve reward for that risk at the next round of funding.
We can get into the details of the mechanics in another article, but for now, understand that you get your foot in the door as an investor, the company can quickly capitalise itself and everyone can get on with their busy lives.
There are, however, downsides as well. Namely, the investment does not provide the investor with voting or other economic participation rights in the company – this only comes in at the next round of funding.
Furthermore, the investor does not become a creditor of the company, meaning that the company is not obliged to pay back the investor, save upon the happening of certain events, usually defined as ‘liquidity events’. In conclusion, upon that next round of funding occurring, the investor’s SAFE converts into a subscription for preferred shares.
So how does the Most Favoured Nation Clause fit into all of this? Quite simply, it allows the SAFE holder to improve its position should a subsequent SAFE or similar convertible instrument be issued to anyone, with terms preferable to the current investor’s SAFE instrument. It allows the SAFE holder to request the company to amend and restate its SAFE instrument to be identical to the instrument(s), evidencing the subsequent convertible instrument.
It is important to note, however, that this does not usually present the SAFE holder with a right ad infinitum. Unless the subsequent instrument includes a similar MFN provision, the SAFE holder usually loses his or her right to update his/her SAFE instrument 2.0 should a future and even more preferable instrument rear its head before the next round of funding.
This clause is a fascinating incorporation of international principle into contract law and the investment world; however, should you end up with such a clause, you are urged to use it wisely.
