[co-author: Kendrick Hardison]
For many early-stage startups, choosing between a convertible note and a SAFE (Simple Agreement for Future Equity) is one of the first critical legal and strategic financing decisions. While both instruments allow companies to raise capital without setting a valuation upfront (unlike a Series Seed Preferred Stock financing), they carry important differences in structure, risk, investor expectations and long-term implications. Understanding these differences will help founders select the right tool based on their company’s goals, growth trajectory, and investor profile.
The Basics: Similar, But Not The Same
Both convertible notes and SAFEs are designed to delay pricing equity until a later financing round, typically a priced Series Seed or Series A financing. They convert into preferred stock at the closing of such an event, often at a negotiated discount or valuation cap that rewards early investors for their increased risk and early support.
But the similarities end there.
- Convertible notes are debt instruments: they carry interest, have a maturity date, and create repayment obligations if a trigger/conversion event does not occur.
- SAFEs are not debt (and maybe not equity): they are contractual rights to future equity and do not accrue interest or mature.
Each option can appeal to different investor types and situations.
Pros and Cons: SAFEs
- Advantages:
- Lightweight and founder-friendly
- No maturity date means no looming repayment event
- No interest accrual simplifies cap table projections and lessens dilution
- Widely accepted by high-profile accelerator programs like Y Combinator
- Risks and Challenges:
- No creditor protections for investors, which some see as a red flag
- No fixed timeline to convert, which may frustrate investors anxious to become stockholders
- Can result in unexpected dilution if not modeled properly, especially under post-money SAFEs
- Use Case Fit: Early-stage startups raising rounds from friends, family, or early angels, especially when speed and simplicity matter most.
Pros and Cons: Convertible Notes
- Advantages:
- More familiar to traditional angel and early-stage VC investors
- Investor protections through maturity, default and interest obligations
- Can provide downside protection in a failed startup scenario because debt gets paid first
- Risks and Challenges:
- Debt adds complexity to the company’s financial picture
- Risk of triggering repayment if maturity date is reached without conversion
- Negotiation of terms (interest, repayment, conversion triggers) can increase legal costs
- Use Case Fit: Companies seeking more institutional investors or raising a bridge round between priced financings.
Valuation Caps and Dilution: A Shared Feature with Big Impact
Both SAFEs and convertible notes often include a valuation cap, which determines the maximum valuation at which the investor’s investment will convert into equity. This protects early investors from being overly diluted by high valuations in future rounds when the instrument will convert.
Example: A $1 million SAFE with a $10 million post-money valuation cap in a round priced at $20 million will convert as if the company were valued at $10 million (i.e. 10% fully-diluted prior to the new money).
Founder Tip: Run pro forma cap tables to model dilution under different scenarios. Post-money SAFEs, in particular, can be deceptively dilutive if you “stack” too many.
Common Missteps to Avoid
- Using SAFEs as a long-term solution: SAFEs work best as temporary bridges to a priced round, not as ongoing funding tools.
- Mismatched expectations with investors: Not all investors accept SAFEs. Clarify early whether your target backers are comfortable with your proposed instrument.
- Ignoring side letters: Adding investor rights or modifications via side letter can defeat the purpose of a simple agreement. Keep it clean unless your legal team advises otherwise.
- Failing to revisit maturity dates on notes: Avoid accidental defaults by tracking note timelines and planning conversions or extensions by amendment before maturity.
How to Choose
Ask yourself:
- Is my investor comfortable with equity risk and willing to accept a SAFE?
- Do I need a defined conversion timeline, or can I operate without one?
- Will I likely raise a priced round soon, or is this a longer-term bridge?
- Am I prepared to model out dilution impact from valuation caps and conversion terms?
When in doubt, involve your legal counsel early. The structure you pick today will impact your company’s leverage, relationships, and cap table for years to come.
Convertible notes and SAFEs are powerful financing tools, but they are not interchangeable. Each comes with trade-offs in control, cost, complexity and investor sentiment. The best choice depends on your fundraising goals, investor base and time horizon. Done right, either one can help provide the capital to launch your company to its next milestone—just make sure you know what you're signing up for.
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