SAFE Notes vs. Convertible Notes: How They Work
When startups raise early-stage funding, they often use SAFE notes or convertible notes instead of traditional equity. These instruments let investors provide capital now in exchange for future equity when a major funding event (like a Series A round) occurs.
1️⃣ What is a SAFE Note? (Simple Agreement for Future Equity)
✅ Invented by Y Combinator to simplify startup fundraising.
✅ Not debt—no interest or maturity date.
✅ Investors give money now and receive equity later when the company raises a priced round.
How it works:
- An investor gives a startup, say, $100K.
- When the startup raises a priced round (e.g., a Series A), the SAFE converts into preferred stock at a discounted valuation.
🔹 Example:
- A SAFE note with a 20% discount converts at a lower price than new investors in the Series A round.
🔹 Why founders like it:
- No repayment pressure (unlike debt).
- Faster & simpler than convertible notes.
- No interest or maturity date.
2️⃣ What is a Convertible Note?
✅ A form of debt that converts into equity in the future.
✅ Has an interest rate and maturity date (unlike SAFE notes).
✅ Used when investors want legal protection and a clear repayment timeline.
How it works:
- Investor lends $100K to a startup as a loan.
- Loan accrues interest (e.g., 5% per year).
- At the next funding round, the loan + interest converts into equity at a discounted price.
- If no funding round occurs, the investor can demand repayment at the maturity date.
🔹 Example:
- If a startup raises at $10M valuation but an investor has a 20% discount, they buy in at an $8M valuation.
🔹 Why investors like it:
- Legal protection (since it’s debt).
- Interest accumulation increases returns.
- Maturity date forces startups to raise or repay.
3️⃣ Key Differences: SAFE Notes vs. Convertible Notes
| Feature |
SAFE Note |
Convertible Note |
| Type |
Equity agreement |
Debt (loan) |
| Maturity Date |
❌ No maturity date |
✅ Has a deadline (e.g., 18-24 months) |
| Interest Rate |
❌ No interest |
✅ Accrues interest (e.g., 5-8%) |
| Legal Simplicity |
✅ Simple |
❌ More complex |
| Risk for Founders |
✅ Less risk |
❌ More risk (debt must be repaid if no funding event) |
| Investor Protection |
❌ Less protection |
✅ More protection |
4️⃣ Which One Should You Use?
🔹 Use a SAFE note if:
✅ You want a simple, founder-friendly agreement.
✅ You don’t want debt on your books.
✅ You’re raising money from angel investors or accelerators.
🔹 Use a Convertible Note if:
✅ Investors want legal protection and interest.
✅ You need a maturity deadline to push for funding.
✅ You’re raising from more traditional investors (e.g., VCs, banks).
🌟 Final Thoughts
Both SAFE notes and convertible notes are great tools for raising early-stage funding without setting a valuation too early.