The Israel Tax Authority’s Guidance

Yesterday, following extensive discussions with leading advisors, with the participation of our firm, the Israel Tax Authority (the “ITA”) published an updated version of the guidance document originally issued on May 16, 2023, regarding the tax classification of Simple Agreement for Future Equity (“SAFE”) instruments as investment instrument for tax purposes (the “Updated Guidance” and the “2023 Guidance”, respectively). See our comprehensive client update on the Original Guidance here. This new version aims to enhance clarity and address ambiguities identified since the issuance of the 2023 Guidance.

Key Revisions in the Updated Guidance

1. Increased Investment Cap: The allowed investment amount through a SAFE has been increased from NIS 40 million to USD 20 million.
2. Expanded Conversion Flexibility: The Updated Guidance permits SAFE conversion into shares on a predetermined date (not only a predetermined event), including at a discounted price.
3. Discount Rate Flexibility: A bracketed discount rate mechanism is now allowed in a SAFE.
4. Extended Applicability: Unlike the 2023 Guidance, which applied to SAFEs signed until December 31, 2024, the Updated Guidance applies to SAFEs signed between January 1, 2025, and December 31, 2026, and can also be used for interpreting the provisions of the 2023 Guidance.

The Conditions of the Green Route

Below is a summary of the conditions required for classifying a SAFE as a capital instrument, in accordance with the Updated Guidance. These conditions are cumulative, meaning all must be met for the green route to apply.

1. The company and its activities

• • The investment is made in an Israeli resident private high-tech company;

• • The majority of the company’s expenses are classified as research and development (R&D) or related to the manufacturing/marketing of products developed through R&D, as recorded in its audited financial statements during either: (i) the three years preceding the date of signing the SAFE; or (ii) the entire period from the company’s establishment (if less than three years);

• • The above-mentioned R&D activities are ongoing at the time the SAFE is signed;

• • The majority of the company’s asset value is not derived, directly or indirectly, from Israeli real estate (including rights in real estate or real estate corporation or a right to exploit natural resources in Israel or a right to receive benefits from real estate in Israel).

2. No previous funding round took place at a known valuation – The company did not raise funds based on a known valuation during the three-month period preceding the closing date of the SAFE.

3. Investment limit – The 2023 Guidance limited the amount invested through the SAFE, directly or indirectly, to NIS 40M per investor. This cap was increased to USD 20M per investor.

4. Limitation on the investor’s ability to transfer the SAFE to a third party – The SAFE determines that until conversion, transferring the SAFE to a third party requires company approval, except for permitted transferees.

5. The title of the investment agreement – The SAFE is not titled as “Loan Agreement” or “Debt”, which may suggest it be treated as a debt instrument.

6. The conversion mechanism – Since there has been some ambiguity on this matter, the Updated Guidance slightly revised the requirements for the conversion mechanism of the SAFE. The Updated Guidance requires that the SAFE specify that the conversion of the SAFE into shares (or rights to receive shares) be carried out at the earliest of the following pre-determined events:

• • On the date of a “Qualified Finance Event”. A Qualified Finance Event is defined as a round in which (1) the amount raised exceeds 10 times the total amount of the company’s outstanding SAFEs, or (2) the capital raised exceeds 40% of the pre-money share capital of the company on a fully-diluted basis. It should be noted that the Updated Guidance does not preclude the conversion of a SAFE in a funding round that does not qualify as Qualified Finance Event;

• • On the date of an IPO;

• • On the date of an exit event in which a majority of the company’s shareholders sell their shares. For this purpose, the calculation is based on the number of shareholders and not the shares sold, disregarding holders of options, or sales of options or shares underlying options granted to employees or advisors of the company;

• • Within a transaction in which the company sells the majority, or all, of its assets; or

• • On a specific pre-determined date stated in the SAFE, provided that the conversion price is pre-determined as one of the following: (i) a set price; (ii) the price per share in the current or the following round – with or without a pre-determined discount.

7. The investor is not entitled to a repayment – The SAFE does not entitle the investor to a repayment of an investment amount other than conversion into shares, and no agreed date for such repayment has been determined in advance in the SAFE, except if one of the following events occurs (each, a “Trigger Event”):

• • The majority of the company’s shareholders sell their shares to a third party (other than the company or a shareholder that owns 25% or more of the shares in the company);

• • A Voluntary liquidation;

• • An Involuntary liquidation;

• • The appointment of a receiver or a special administrator by one of the following: (i) the State Official Receiver; (ii) a court of law; or (iii) the Law Enforcement and Collection System Authority; or

• • General assignment of rights to creditors.

The SAFE determines that upon the occurrence of a Trigger Event, the investor is only entitled to a repayment of his/her/its principal investment amount.

8. The SAFE is subordinate to other commitments of the company – The SAFE is subordinate to other company obligations, except in liquidation scenarios where it carries priority over ordinary shares.

9. The company has not committed to pay the investor any consideration not otherwise paid to its shareholders – The company did not contractually commit to pay the investor any cash or in-kind receipts, such as interest, royalties or any other type of consideration that differs from any consideration the company pays to its other shareholders. This condition must be met throughout the period from the date of investment until the date of conversion of the SAFE into shares.

10. The benefit granted to the SAFE investor is not compensation for the value of time – The 2023 Guidance determined that the benefit granted to the investor under the SAFE would not increase as a linear function of the time that has passed. The Updated Guidance slightly relaxes this limitation, and allows for up to three discount brackets, tied to milestones or time elapsed, with the maximum discount applying no later than three years from issuance of the SAFE.

11. Absence of liens or guarantees – No liens or pledges are imposed on the company’s assets and no guarantees are provided to the investor by the company or its subsidiaries or related companies in connection with the SAFE.

12. No expenses are deducted in connection with the SAFE – The company does not claim any finance expenses or expenses that are related directly or indirectly to the SAFE, by way of recording finance expenses, capitalizing financing costs, revaluation of a liability or any other way.

13. Conversion date – The conversion of the SAFE into shares occurs as part of a funding round in which at least 25% of the funding in the round was raised from investors who/that are not SAFE investors. The Updated Guidance further clarifies this requirement, allowing funding to be received from SAFE investors, provided the investment is not made in their capacity as SAFE investors and no single SAFE investor owns more than 50% of the company’s shares (before or after the round).

14. Minimal holding period – The investor held the shares received following conversion of the SAFE and prior to their sale for a minimum period, determined as one of the following (the “Minimal Holding Period”):

• • 12 months from the date on which the SAFE was signed; or

• • 9 months from the date of the conversion of the SAFE into shares.

The 2023 Guidance included a grandfathering provision for SAFEs entered into prior to the lapse of 30 days from the date of its publication. As this period has passed, the grandfathering provision was omitted from the Updated Guidance.

Forced transaction exception: the Minimal Holding Period would not apply if either the conversion of the SAFE or the sale of the shares underlying the SAFE following its conversion occurred as part of a Trigger Event (see section 7 above).

15. Price per share – The price per share used to determine the consideration that the SAFE investor is entitled to receive is equal to the price per share determined for other shareholders holding the same type of shares, disregarding for this purpose, the benefit, if any, specified in advance in the SAFE.

Looking Ahead

The Updated Guidance applies to SAFEs signed between January 1, 2025, and December 31, 2026, unless revised guidance is issued prior to that date. It can also be used for interpreting provisions of the 2023 Guidance.

In light of the conditions specified in the 2023 Guidance and the Updated Guidance, proper drafting of SAFEs can save the company and its investors significant tax costs and unnecessary dealings with the ITA. Companies that previously used SAFEs or other convertible instruments for raising capital (such as convertible loan agreements or advance investment agreements) should examine the potential implications of the guidance letters on such instruments and how to address instruments that do not meet their conditions. It may also be advisable to review SAFEs signed since the issuance of the 2023 Guidance following the publication of the Updated Guidance.

Our Tax Department has extensive experience in these matters and would be happy to assist with understanding the potential tax implications of investing through SAFEs or other convertible instruments and optimizing tax efficiency.