SAFEs (Simple Agreements for Future Equity) and convertible notes are two of the most widely used instruments for early-stage startup financing. Designed to be faster, simpler, and more founder-friendly than traditional equity rounds, both allow investors to fund a company in exchange for the right to receive equity at a future date—typically during a priced funding round.
While they share similarities, each has its own legal structure, risk profile, and implications for investors and founders.
What Is a Convertible Note?
A convertible note is a form of short-term debt that converts into equity upon a triggering event, usually the company’s next equity round. Key features include:
- Principal + Interest: Accrues interest (e.g., 5%–8%) until conversion or maturity
- Valuation Cap: A maximum valuation at which the note converts
- Discount Rate: Investors receive shares at a discount (e.g., 20%) to the next round’s price
- Maturity Date: If no conversion event occurs, the note may be repayable or renegotiated
Convertible notes are legally debt instruments, which may give investors default rights—but can also pressure startups as maturity approaches.
What Is a SAFE?
A SAFE is not debt. It is an agreement to convert invested capital into equity upon a future equity financing or liquidity event. Originally developed by Y Combinator, SAFEs have become a standard in early-stage startup funding.
Key features:
- No Interest or Maturity: Unlike notes, SAFEs don’t accrue interest or need repayment
- Valuation Cap and Discount: Similar incentives as convertible notes
- Trigger Events: Convert during the next priced round, acquisition, or IPO
SAFEs are simpler, cheaper to execute, and founder-friendly—though they offer fewer investor protections.
Why Investors Use SAFEs and Notes
- Speed: Deals can close quickly without negotiating full terms or valuations
- Early Entry: Gain exposure to startups at early valuations
- Future Equity: Benefit from company growth with equity at favorable terms
Risks and Considerations
- No Control Rights: Typically no board seats or voting power
- High Risk: Early-stage startups have high failure rates
- Dilution: Future funding rounds can impact your ownership
- Uncertain Exit: If no priced round occurs, conversion or repayment may be delayed indefinitely
SAFEs and convertible notes are flexible tools that bridge the funding gap for startups before institutional rounds. For investors comfortable with uncertainty and long-term horizons, they offer the chance to invest early in potentially disruptive companies—often with better terms than later-stage participants. But they also demand careful consideration of legal terms, conversion mechanics, and founder credibility.
