The Complexity Creep: How Side Letters are Turning SAFEs into Complicated Investments

In 2013, Y Combinator introduced the Simple Agreement for Future Equity (“SAFE”) with the intention of creating a “simple and fast way to get that first money into the company”. This revolutionised the way early-stage companies raised funds. The idea was simple: provide a consistent and predictable mechanism for investors to put money into startups without the complexities of a full-blown funding round.

SAFEs became very popular in the US and European markets as they offered transparency and ease of use for both founders and investors. However, in the African ecosystem things are different. Where SAFEs work well for fast growing companies, geared at unicorn status, African startups often require much more funding, over a longer period, to get to a stage where they can raise a priced round.

To protect investor interests, investors on the continent are increasingly attaching side letters to SAFEs, complicating what was once a simple and predictable agreement. Given the African landscape, side letters can protect and mitigate against certain investor risks, which in turn encourages investment in African startups. However, this becomes a problem when the side letter includes bespoke provisions, effectively transforming the SAFE into a more complex investment tool. This shift is concerning for founders who value the intended simplicity and predictability of SAFEs.

The side letters we’ve seen lately exemplify this trend. They introduce several additional provisions that go beyond the basic structure of a SAFE. For instance, while we have no objection to pro-rata rights – which allow investors to maintain their ownership percentage in future funding rounds – the side letters also stipulate that the SAFE will convert into shares with specific, pre-agreed features which often require extensive negotiation between the founders and the investors. This significantly deviates from the original intent of a SAFE and undermines one of its core advantages: simplicity.

Side letters often seek to provide additional rights and protections to investors, such as board seats, information rights, and strategic involvement clauses. These provisions, while not inherently problematic, add layers of complexity that can be burdensome for startups who are not proficient or experienced in negotiating these positions yet. These provisions transform what was supposed to be a simple funding transaction into something that requires careful legal scrutiny and ongoing management.

For founders, this means more time and money spent negotiating and managing investor relations, rather than focusing on building their business. The original intent of the SAFE was to avoid precisely this kind of complexity.

These side letters also introduce a new risk: future funding rounds may face challenges if the future lead investor disagrees with the pre-agreed features of the shares into which the SAFE will convert. Each new funding round typically involves new investors who bring their own expectations and requirements. If the pre-agreed terms in the side letter conflict with what future investors find acceptable, it can lead to disagreements and delays in securing additional funding. This can put the startup in a difficult position, potentially jeopardising its growth plans and financial stability.

In conclusion, while side letters attached to SAFEs may offer certain advantages to investors, they compromise the simplicity and predictability that made SAFEs attractive in the first place. Founders should be aware of this trend and carefully consider the implications of any additional provisions before agreeing to them. Maintaining the simplicity of a SAFE can help ensure that fundraising remains a streamlined and efficient process, allowing founders to remain focused on growing their business and avoiding potential complications in future funding rounds.

Interested to find out more?

Sign Up To Our Newsletter