SAFE And Sound: How Ontario Startups Can Raise Capital Smartly

Raising money as a startup in Ontario can feel like navigating a maze of legal documents, investor demands, and financial uncertainty. That's where SAFEs, or Simple Agreements for Future Equity, have emerged as a startup-friendly shortcut.

Initially developed by Y Combinator in Silicon Valley, SAFEs are now gaining traction in Canada, particularly among early-stage Ontario startups seeking a quicker, cheaper, and more flexible way to raise capital. Unlike traditional priced equity rounds, which require company valuation, shareholder agreements, and complex term sheets, or convertible notes that function like debt with interest and maturity dates, SAFEs simplify the process, making it more accessible and less daunting for startups.

Think of it like planting a seed: the investor provides capital today, trusting it will grow into equity once the startup flourishes in a future funding round. This flexibility and potential for growth are what make SAFEs popular in Ontario's growing startup ecosystem, offering a promising path for startups to secure funding and thrive.

With more incubators, accelerators, and angel investors operating here than ever, SAFEs are helping Ontario founders move quickly without being bogged down by legal and financial red tape. Consequently, it has become vital for potential and current startup owners in Ontario to familiarize themselves with these types of agreements.

What is a SAFE Agreement, and How Does it Work?

A Simple Agreement for Future Equity (SAFE) is a straightforward legal instrument that enables investors to provide capital to a startup in exchange for the right to receive equity at a future date. Unlike traditional convertible notes, a SAFE is not a debt instrument. It doesn't earn interest, has no maturity date, and doesn't require the startup to repay the investment. Instead, the investor buys the right to get future equity on agreed terms, rather than lending money to the company.

The primary purpose of a SAFE is to delay the often complex valuation discussions that accompany early-stage equity financing. By pushing these talks to a later stage when the startup is more established, SAFEs help founders and investors negotiate equity at a more informed time. In Canada, startups typically use one of two SAFE templates: the Y Combinator Canada SAFE or the National Angel Capital Organization (NACO) Canadian SAFE. The NACO version incorporates changes to better align with Canadian legal rules and market expectations, including optional maturity dates and specific valuation methods.

When a founder signs a SAFE agreement, an investor gives immediate capital in exchange for future equity rights. There are no shares issued upfront, no valuation talks at this time, and no obligation to repay the money. This simplicity enables founders to raise funds quickly, often with minimal legal costs and without compromising control or board seats.

Over time, the startup uses this funding to develop its product, gain traction, and grow. The SAFE remains on the company's records until an event occurs that triggers its conversion, typically a priced equity round. When this happens, the SAFE automatically changes into shares of preferred stock. The calculation for conversion is based on the better of the valuation cap or the discount rate, ensuring a clear and straightforward process for founders and investors.

• Conversion Price Calculation Example: If a SAFE has both a valuation cap and a discount rate, the conversion price is determined by the lower of the two: either the valuation cap or the discounted preferred price.
• Conversion Price (Valuation Cap): Valuation Cap ÷ (Outstanding Shares + Outstanding Options + Option Pool Increase).
• Conversion Price (Discount Rate): (1 – Discount Rate) × Preferred Price Per Share in the New Round.

To determine the number of shares issued to the SAFE holder, the SAFE Investment Amount is divided by the conversion price. For example, suppose an investor gives $100,000 through a SAFE that has a $5 million valuation cap and a 20% discount. The startup raises a priced round at a $10 million valuation with shares priced at $1.00 each. In that case, the SAFE holder will convert at the valuation cap. This means their effective share price is $0.50 ($5M cap / $10M valuation = 0.50 price factor). They will receive 200,000 shares ($100,000 / $0.50 per share) rather than 100,000 shares they would have received without the favourable terms.

The process typically involves defining terms with legal advisors, drafting the SAFE agreement using a template, issuing the SAFE notes, collecting funds, and ultimately converting the SAFE into equity upon the occurrence of the triggering event.

Key Terms & Components of a SAFE:

Understanding the key components of a SAFE is important for founders. Minor changes to these terms can have a significant impact on a company's capitalization table, founder dilution, and an investor's return.

1. Valuation Cap: This sets the highest company valuation at which the SAFE investment will turn into equity during a future financing round. It protects early investors by ensuring they get a better equity price if the startup's valuation rises significantly. For instance, if a SAFE has a $5 million valuation cap and the startup later raises a Series A at a $10 million valuation, the SAFE holder will convert at the lower cap, securing a larger ownership stake. The lower the valuation cap, the more shares the SAFE investor can buy for each dollar invested. Valuation caps can apply to either pre-money or post-money valuations, which can significantly affect founder dilution.

• The Y-Combinator Canada SAFE typically uses a post-money valuation cap. This clarifies the amount of ownership sold and makes it easy to calculate for both founders and investors. This aims to help founders line up their intentions with the outcomes regarding dilution.
• The NACO Canadian SAFE uses a pre-money valuation cap.

2. Discount Rate: Often offered alongside or in place of a valuation cap, a discount rate enables investors to pay less per share when the SAFE converts. This ensures that early supporters receive equity on better terms than new investors in the subsequent round. Discounts typically range from 10% to 30%, with 20% being the most common discount offered. For example, a 20% discount allows an investor to convert their investment into shares at 80% of the price new investors pay in the priced round.

3. Triggering Events (Conversion Events): SAFEs become equity upon the occurrence of specific events. The main events are further explained as follows:

• Equity Financing: A future-priced equity round, typically Series A, is the most common conversion trigger. The SAFE automatically turns into shares of preferred stock at this point.
• Liquidity Event: If the company is acquired or goes public (IPO) before a priced round, the SAFE will either convert or provide the investor with a return. This conversion is treated as a liquidity event, with investors receiving shares or cash based on negotiated terms, such as the valuation cap and discount rate.
• Dissolution Event: If the company shuts down, investors may get a part of the proceeds. However, SAFEs rank below debt and carry a risk of total loss. If a SAFE never converts, the investor generally loses their investment. However, in rare cases, they may be able to negotiate a repayment arrangement.

4. Most Favoured Nation (MFN) Clause: An MFN clause gives SAFE investors the right to accept any better terms offered in future SAFEs issued by the company. This promotes fairness among early-stage investors and can alleviate the pressure on founders to negotiate new deals continually.

5. Pro-Rata Rights (Participation Rights): Some SAFEs include pro-rata rights, which allow investors to participate in future equity rounds to maintain their ownership percentage and avoid dilution. While these rights may not always be included in the SAFE itself, they are often covered through a side letter.

SAFE Frameworks in Canada and Ontario:

While SAFEs originated in the U.S. through Y Combinator, Canada, particularly Ontario, has begun creating its versions to suit its legal environment. The NACO Canadian SAFE is a local template developed by the National Angel Capital Organization. It is designed to comply with Canadian corporate laws. It reflects our local investor practices while maintaining the same startup-friendly spirit as the original YC SAFE.

In Ontario, using a SAFE involves more than just completing a template and making a deal. Founders need to understand key legal points, particularly those related to securities law. SAFEs are seen as a type of security, so they must comply with the Ontario Securities Act. Most startups maintain a "private issuer" status, which allows them to raise funds from accredited investors, such as angels or VCs, without needing a prospectus, as long as they stay within constraints on who and how many they sell to.

One can view the U.S. YC SAFE as a passport and the Canadian/NACO SAFE as a customs-cleared version. It is adapted for local rules but still leads to the same destination: future equity. Ontario founders enjoy global best practices with a Canadian legal twist, making SAFEs both startup-smart and legally sound.

Regarding the involvement of courts, there is a dearth of decisions that specifically address SAFE agreements. However, one can still draw essential lessons from related Canadian and Ontario cases that highlight specific key legal themes relevant to SAFEs:

1. Confidentiality, fiduciary duties, and equitable constructs: The Supreme Court of Canada has emphasized that detailed confidential disclosures and business relationships can give rise to obligations, such as constructive trusts, if abused. This underscores the importance of startups using SAFEs to handle sensitive term negotiation and conversion triggers carefully.
2. Implied duties and the "good faith" principle: Ontario courts recognize that even if a contract—like a confidentiality or standstill agreement—doesn't expressly include a duty of good faith, courts may imply it where necessary to uphold fair commercial expectations. For SAFEs, unreasonable behaviours (e.g., overtly dilutive cap table manipulation) might not be enforceable if they defeat the original intention of the deal.
3. Clarity and enforceability: It has also been reiterated by courts that agreements, especially cross-border ones, must be clear and unambiguous to be enforceable in Ontario. Since SAFEs involve future equity conversions, valuation caps, and trigger events, precise drafting is critical for Ontario startups to ensure they're upheld under local law.

Pros and Cons of Using a SAFE:

Part I: Why Startups Choose SAFEs- Benefits to Founders:

1. Speed and Simplicity: SAFEs are short, standardized legal documents with fewer terms to negotiate. This allows for quick execution and faster capital raising. It is ideal for time-sensitive opportunities and can be completed quickly with minimal legal costs.
2. Deferring Valuation: SAFEs enable startups to delay discussions about valuation until they have gained more traction. This way, they can negotiate from a stronger position and avoid the risk of being undervalued too early.
3. Cost-Effective Fundraising: Legal fees for SAFE rounds are much lower than for equity financing or convertible notes. This makes SAFEs appealing for smaller fundraising amounts, such as under $500,000.
4. Non-Debt Structure: Since SAFEs are not debt instruments, they do not have interest payments or maturity dates. This provides founders with breathing space, eliminating the stress of repayment obligations or deadlines, and making SAFEs a less burdensome option during early development.
5. Founder-Friendly: SAFEs enable founders to maintain more control without relinquishing board seats.

Part II: Risks and Limitations of SAFEs- What Founders Must Watch For:

Despite their advantages, SAFEs have drawbacks.

1. Dilution Risk: Issuing multiple SAFEs over time, particularly with varying terms, can result in significant and unexpected dilution upon conversion.
2. Cap Table Complexity: Managing various SAFEs with different valuation caps, discounts, and MFN clauses can complicate the company's capitalization table. This makes it harder to understand ownership percentages and structure future funding rounds. Calculating equity distribution can become very complicated.
3. Investor Uncertainty: Since SAFEs do not provide equity or rights until a conversion event, some investors may feel uneasy about the indefinite timeline and lack of control. Founders should communicate their expectations to maintain high investor confidence.
4. Fewer Investor Protections: Unlike traditional priced equity rounds, SAFEs typically offer fewer protective provisions and investor rights, such as voting rights and information rights. This may discourage some sophisticated or institutional investors.
5. Legal and Regulatory Compliance: Although simpler, SAFEs are still considered securities and must comply with Ontario's securities laws, which are administered by the Ontario Securities Commission (OSC). Startups need to either file a prospectus or rely on an exemption, often the accredited investor exemption under National Instrument 45-106. It is essential to consult legal counsel to ensure proper compliance.
6. Accounting Complexity: The accounting treatment of SAFEs can be complicated, and there may be tax implications for both the company and investors during the conversion process. Companies should work closely with accountants and advisors.
7. Sophistication Required: SAFEs require a certain level of sophistication to negotiate, understand, and execute properly. This makes them best suited for founders and investors who grasp the startup financing framework.
8. Potential for Future Complexity: Although SAFEs are simple at the beginning, legal issues and complications can arise during a conversion event due to the interaction of SAFE terms with preferred share terms in the next round of financing.

Step-by-Step: How to Set Up a SAFE in Ontario (in 5 Simple Steps):

Step 1: Pick Your Map and Choose the Right Template: Start with a solid foundation. Use either the Y Combinator SAFE (common worldwide) or the NACO Canadian SAFE, which is tailored for Canadian legal and tax standards. The NACO version avoids U.S.-centric language and ensures you comply with local laws. Think of this like choosing between Google Maps and Waze—both get you there, but one speaks your language.

Step 2: Negotiate the Treasure Markers, Key Deal Terms: Work with your investor to finalize the main deal terms ( investment amount, valuation cap, discount rate, investor rights).

–To avoid needing a full prospectus, most Ontario startups use the private issuer exemption under the Ontario Securities Act. This means:

• You can only issue SAFEs to a limited number of investors (not more than 50 non-employees).
• Your investors must qualify as accredited investors (usually based on income or net worth).

Step 4: Do the Paperwork, Corporate Approvals: Once the deal is agreed:

• Pass a board resolution** approving the SAFE issuance.
• Update your capitalization table (cap table) to reflect the new future equity commitment.
• Securely store executed agreements (digital copies and legal records).

Step 5: Record and Report, If Needed: Although SAFEs do not issue shares right away, it's smart to:

• Log them in your internal share ledger under a "Future Equity" section.
• Inform investors of any triggering events (like a priced round) promptly.

By following these five steps, Ontario founders can use SAFEs to raise early-stage capital without the legal and financial complexity of traditional equity rounds. It's like trading a legal jungle for a well-lit shortcut with guardrails.

Hiring a Lawyer for SAFE Agreements:

Hiring a lawyer to handle SAFE agreements in Ontario ensures compliance with securities laws, protects against unclear terms, and prevents future disputes. Legal advice helps create fair, enforceable deals, manage investor rights, and maintain private issuer status. This is critical for startups that want to raise funds while reducing risk and keeping long-term control of equity.

Pacific Legal provides complete legal support for startups and investors entering SAFE (Simple Agreement for Future Equity) agreements in Ontario. Our team knows the unique needs of early-stage financing. We are familiar with both Y Combinator and NACO Canadian SAFE frameworks, so your agreements meet Ontario corporate and securities laws. We handle everything from drafting customized SAFE contracts and negotiating important terms to advising on private issuer exemptions and investor qualifications. We help you navigate the process clearly and confidently. With a focus on practical solutions and straightforward pricing, Pacific Legal makes sure your SAFE agreements are legally sound and ready for investors. Working with us means you get legal expertise specific to Ontario and strategic support for your startup's fundraising efforts.

Conclusion

SAFE agreements have revolutionized early-stage startup financing, offering a fast, flexible, and founder-friendly mechanism for raising capital. For Ontario-based founders, SAFEs are particularly valuable when speed and simplicity are crucial, and when determining a full valuation may be challenging. However, the benefits of SAFEs must be weighed against their potential for dilution, investor uncertainty, and regulatory obligations. A thoughtful approach—grounded in a solid understanding of SAFE mechanics and legal compliance—can allow founders to maximize the advantages while minimizing risks. When executed with foresight and strategic planning, SAFEs can serve as a robust foundation for early growth and long-term success.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.