📄 Convertible Notes vs. SAFEs

🎉 Happy Friday, funds family!

Most early-stage startups raise their first capital using a convertible note or a SAFE rather than a 📄 priced equity round. It’s an important topic for the companies and the investors who use these instruments, because the differences between them (e.g., legal form, investor protections, and conversion mechanics) affect what happens if the company does not raise a priced round on schedule and can meaningfully change the economics for both sides.

The short answer is: a convertible note is debt with an interest rate and a maturity date, while a SAFE is not debt at all (it has neither component). Both are designed to convert into equity at a future priced round, typically at a capped valuation (or, less commonly, a discount) favorable to the early investor, but the legal form matters most when a priced round is delayed, when the company winds down, or when multiple instruments are stacked and need to be modeled together.

➡️ What is a convertible note?

A convertible note is a debt instrument: the company borrows money from the investor, promises to repay it (with interest), and the debt converts into equity (preferred stock) upon a future qualifying financing, or is repaid in cash if that financing never happens and the note matures. Key terms include:

• Interest rate: notes accrue interest, usually ~4–8% annually, which typically converts into additional shares at conversion rather than being paid in cash.

• Maturity date: the date by which the note must convert or be repaid, typically ~18–24 months from issuance.

• Valuation cap and/or discount: mechanisms that give the note holder a better price than the new round investors, described further below.

Because it is debt, a convertible note usually sits ahead of all equity, including preferred stock, in a liquidation, and it carries a maturity date that creates real pressure on the company if a priced round has not happened by then.

➡️ What is a SAFE and how is it different?

A 📄 SAFE (Simple Agreement for Future Equity), created by Y Combinator, is not debt. It has no interest rate and no maturity date. It is a contractual right to receive equity in the future, typically upon the company’s next priced equity financing, though also potentially upon a change of control or dissolution. Because there is no maturity date, there is no deadline forcing repayment or renegotiation if a priced round is delayed.

SAFEs use the same core economic mechanisms as notes to give early investors a better price than later investors:

• Valuation cap (post-money): the maximum company valuation used to calculate the SAFE holder’s conversion price, regardless of the price set in the priced round.

• Discount: a percentage reduction off the price per share paid by new investors in the priced round.

• Most SAFEs include a valuation cap, a discount, or both (a cap alone is most common); where both apply, the holder converts at whichever produces the lower price.

➡️ What are the practical differences that matter?

The legal instrument drives several practical consequences:

• Because a SAFE is not debt, it does not accrue interest and does not appear as a liability requiring repayment on the balance sheet in the same way a note does, though both are typically tracked as liabilities until conversion.

• Because a note has a maturity date, a company that has not raised a priced round before maturity must renegotiate, extend, or repay the note: a real source of leverage for note holders and real pressure on the company.

• In a liquidation or wind-down, convertible note holders are creditors and are paid before any equity holders.

• SAFEs are generally simpler and faster to negotiate and close, which is part of why they have become the more common instrument for pre-seed and seed rounds in the current market.

➡️ When does the choice between a note and a SAFE actually matter?

For most seed-stage financings, the choice has become largely a matter of convention (SAFEs dominate that market). It matters more in three situations: when the company is at risk of not raising a priced round quickly, since a note’s maturity date creates a forcing event that a SAFE does not; when investors want the structural protection of being a creditor rather than an equity-like claimant; and when a company has stacked many rounds of notes or SAFEs at different caps, which makes modeling the eventual conversion dilution more complex regardless of instrument.

➡️ The practical takeaway

For the company:

1. Understand that a note’s maturity date is a real deadline: track it and plan the financing timeline around it, not after it becomes urgent.

2. Model the 📄 cumulative dilution from all outstanding SAFEs and notes before pricing the next round; stacking multiple caps without modeling the total conversion is a common and costly mistake.

3. SAFEs are generally faster and simpler to close for early rounds, so use them unless investors specifically require note terms.

4. Keep each SAFE’s and note’s cap, discount, and (for notes) maturity date current on the cap table so the eventual conversion math is not a surprise.

For the investor:

1. Understand your priority in a wind-down scenario: as a note holder you are a creditor; as a SAFE holder you are not.

2. If you want a forcing mechanism to push the company toward a priced round, a note’s maturity date provides one that a SAFE does not.

3. Compare your cap and discount against other outstanding instruments before investing: know where you sit in the eventual conversion stack.

4. For companies raising serial SAFEs or notes, ask to see the cumulative modeled dilution across all outstanding instruments, not just your own term sheet in isolation.

Thanks for reading, everyone!

Have a great weekend! 🙌

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This may be considered attorney advertising.