The Not-So-SAFE Side of SAFEs: Managing Side Letters with Caution
For early-stage Canadian startups, SAFEs (Simple Agreements for Future Equity) have become an increasingly common way to raise seed capital. Originally popularized in Silicon Valley, SAFEs were designed to provide a fast, flexible, and cost-effective alternative to convertible notes or priced equity rounds.
Legally, a SAFE is a contractual right to receive shares in the company at a future financing event, rather than debt. It’s meant to streamline fundraising by avoiding valuation negotiations and interest or maturity dates. But as SAFEs have evolved, so too has their complexity, particularly through the growing use of side letters.
When “Simple” Starts Getting Complicated
What makes a SAFE attractive is its simplicity. Yet it’s increasingly common for investors of all sizes to request side letters that grant them rights outside the standard form, such as:
- Pro rata participation rights in future rounds
- Board observer seats
- Most-favoured-nation (MFN) clauses
- Information and reporting rights
- Conversion or maturity dates
While these rights can be reasonable in isolation, stacking multiple side letters across different investors can quickly create inconsistencies and legal risk.
The Hidden Risks of Side Letters
Agreeing to a side letter might feel like a small price to pay to close a deal, especially when fundraising momentum is critical. But founders should pause before accepting too many exceptions. In practice, side letters can lead to:
- Overlapping or conflicting obligations among investors or existing shareholder agreements
- Unintended breaches of commitments that are forgotten or poorly tracked
- Friction with lead investors in a future priced round, who may insist on clean documentation and reject previous informal arrangements
This complexity can become even more challenging in Canada, where SAFEs are still a relatively new financing tool and market norms are less standardized than in the U.S.
Best Practices for Founders
- Keep your SAFEs clean.
That’s what they were designed for: simplicity. Avoid unnecessary side letters whenever possible.
- If a side letter is unavoidable, confirm alignment.
Review all previous agreements to ensure consistency with existing shareholder terms and anticipated financing documents.
- Set clear expiry terms.
Where appropriate, have the side letter expire upon conversion of the SAFE to avoid carrying legacy obligations into future rounds.
- Stay organized.
Track every side letter you sign and store copies where they can be easily found later. (It sounds obvious, but many founders overlook this step.)
Keep It Simple and Document It Well
Side letters aren’t inherently problematic; they can serve a purpose when used carefully and transparently. But the key is discipline. Too many exceptions to a simple agreement can lead to complexity that undermines the very efficiency SAFEs were meant to provide.
For Canadian startups, maintaining clean documentation and clear records is essential. When in doubt, get advice before you sign. The LaBarge Weinstein team regularly assists founders and investors in structuring SAFE financings that balance flexibility with sound governance.
