SAFE vs Convertible Note: Differences, Examples and Which to Choose

SAFEs and convertible notes do the same basic job. An investor gives you money now, and instead of buying shares at a fixed price, they get the right to receive shares later when you raise a priced round. The differences are in the details, and those details can matter a great deal if things don't go to plan.

The one-sentence difference

A convertible note is a loan that's meant to turn into equity. A SAFE (Simple Agreement for Future Equity) is not a loan at all. It's a contract for future shares with no interest and no repayment date.

Everything else follows from that distinction.

Side-by-side comparison

How a SAFE works

Y Combinator introduced the SAFE in 2013 as a simpler alternative to convertible notes. In 2018 it published the post-money SAFE, which is now the version most people mean when they say "SAFE".

The key terms are:

• Purchase amount: how much the investor puts in.
• Valuation cap: the maximum valuation at which the SAFE converts. If your next round is priced higher than the cap, the SAFE holder converts as if it were priced at the cap, which gives them more shares.
• Discount (optional): a percentage off the next round's price, such as 20%.
• MFN (optional): a "most favoured nation" clause that lets the investor take better terms you later give to other SAFE holders.

With a post-money SAFE, the cap is a post-money valuation that includes all the SAFE money. That makes the investor's ownership easy to estimate: purchase amount divided by post-money cap. $250,000 on a $5 million post-money cap is roughly 5%.

How a convertible note works

A convertible note is a short-term loan with conversion features. The key terms are:

• Principal: the amount invested.
• Interest rate: usually modest, accruing over time. The interest normally converts into shares along with the principal rather than being paid in cash.
• Maturity date: when the note is due if it hasn't converted.
• Valuation cap and discount: the same idea as a SAFE.
• Qualified financing threshold: the minimum size of priced round that triggers automatic conversion.

If you raise a qualifying priced round before maturity, the note converts and life is simple. If you don't, you have to negotiate. Usually noteholders agree to extend the maturity or convert at an agreed price. In theory they could demand repayment, and that potential leverage is the main reason some founders prefer SAFEs.

Conversion maths: a worked example

The interest is the only difference in that example, but on larger raises and longer timelines it adds up. Notice also that a cap well below the next round's price gives early investors a sizeable reward for the risk they took. That's the point of the cap.

Pre-money vs post-money: why it matters

Older SAFEs and most convertible notes use a pre-money cap. That means the cap doesn't include the convertible money itself, and when several instruments convert together they dilute each other. The final ownership is hard to predict until the round happens.

Post-money SAFEs fix each investor's ownership at roughly investment divided by cap. That's clearer for investors. The catch for founders is that every additional SAFE dilutes the founders, not the previous SAFE holders. If you keep raising on post-money SAFEs, your ownership drops faster than you might expect. Model it before you sign. Our cap table guide shows how stacked SAFEs look.

Which should you choose?

A SAFE usually makes sense when:

• you're raising a pre-seed or early seed round from angels and seed funds familiar with SAFEs,
• you want low legal costs and fast closing,
• you'd rather not have a maturity date hanging over you, and
• you're in a market where SAFEs are standard and investors expect them.

A convertible note may make sense when:

• your investors, or local angel groups, prefer notes,
• you're raising a bridge round between priced rounds, where notes are traditional,
• you're in a country where SAFEs are less established or their legal and tax treatment is less clear, or
• investors want the extra protection that debt status provides.

Terms to negotiate

Whichever instrument you use, these are the terms that move value:

1. Valuation cap. The most important number. Set it based on your traction and what comparable companies raise at, not on a wish.
2. Discount. Common figures are 10% to 25%. Many post-money SAFEs have a cap and no discount.
3. Interest rate (notes). Keep it modest. The purpose isn't to earn interest.
4. Maturity (notes). Longer gives you more room. Also agree in writing what happens at maturity.
5. Pro rata rights. Some investors ask for the right to invest in the next round. Reasonable for meaningful cheques; be careful about granting it to everyone.
6. MFN. Fine for early investors when you don't yet know your terms, but be aware it can force you to extend better terms to everyone.

Common mistakes

• Raising on uncapped instruments and later discovering the conversion is far more expensive than expected, or the opposite, which annoys early investors.
• Not tracking every instrument. A forgotten SAFE can surface during due diligence and delay a round.
• Letting notes reach maturity without a plan. Talk to noteholders well before the date.
• Using a non-standard template to save money. Customised documents cost more to review later.

Bottom line

For most early-stage startups in markets where they're standard, a post-money SAFE is the simpler, cheaper choice. Convertible notes still have a place, especially for bridge rounds and with investors who prefer them. Either way, the cap, the discount and the total amount you raise on convertibles matter far more than the name on the document.

What happens if you never raise a priced round

Both instruments are designed around the assumption that you'll eventually raise a priced equity round. Not every company does. Here's how the main scenarios usually play out, though the exact outcome always depends on the wording of your documents.

The bootstrapped-to-profitability case is worth thinking about. A growing number of companies raise a small pre-seed and then grow on revenue. If that's a realistic path for you, discuss with investors upfront what you'd do with outstanding SAFEs, and consider including a conversion mechanism that doesn't depend on a future financing.

Practical tips for running a SAFE or note round

• Keep a single tracker with every investor, amount, cap, discount and signature date.
• Use the same terms for everyone in a given tranche to avoid MFN complications.
• Collect investor accreditation or eligibility confirmations as required by your securities exemption.
• File any required securities notices on time; in the US, that can include a Form D within 15 days of the first sale.