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SAFEs vs Convertible Notes

By Charlie Pascal

When founders are seeking their first financing following efforts to self-fund or “bootstrap,” they typically turn to the “friends and family” round, which ideally serves as a bridge to a subsequent round of funding from institutional investors like angels or venture capitalists.  The friends and family round typically takes shape in the form of one of two investment vehicles: the Convertible Note and the Simple Agreement for Future Equity or “SAFE”. 

This article will compare and contrast these two types of funding options and assumes a basic understanding of each by the reader.  This article will focus on the primary differences between SAFEs and the Convertible Notes as well as the pros and cons of each with respect to the investor and the founders/company.

Similarities Between SAFEs and Convertible Notes

Although there are some significant differences between the Convertible Note and the SAFE (together, the “Investment Options”), we’ll start with the features common to each.

  1. The purpose of each of the Investment Options is to provide a mechanism to accept capital from early investors in advance of a later Series A or similar priced financing round (the “Priced Round”).

  2. Both Investment Options contemplate automatic conversion of an investor’s capital in connection with the Priced Round through one or both of two primary conversion features: the Cap and the Discount.

    • The “Cap” is an agreed upon calculation of the company’s total value or capitalization.  This calculation is used to determine the applicable conversion price of the SAFE by dividing the amount of an Investor’s Purchase Amount by the total number of issued and outstanding shares of stock of the Company immediately preceding the conversion and serves as a ceiling or “cap” on the valuation of the Company used to determine the conversion price. 
    • The “Discount” is simply a percentage (typically 80-85%) of the price per share paid by the investors in the Priced Round.

  3. Despite a perpetuated myth that the Convertible Note is necessarily more complex than the SAFE, both Investment Options can be effectively documented in written agreements totaling no more than 5 pages.

  4. In terms of cost, one of the primary reasons the SAFE came about was to save the company legal expenses.  The idea was to create an extremely short form that prohibited any changes other than filling in blanks, which in theory makes the SAFE less expensive than the Convertible Note.  In reality, the SAFE form is often negotiated, with the template’s advisory note regarding “no changes” being the first sentence to be deleted.

Differences Between SAFEs and Convertible Notes 

While SAFEs and Convertible Notes both serve as an effective bridge for early investors to contribute capital in advance of Priced Round in which such investors are guaranteed to participate at a preferential price, there are some important differences between the Investment Options outlined below:

  1. The Convertible Note is indisputably a debt instrument, while the SAFE’s treatment by accountants is less clear and subject to debate.  As a debt instrument, the Convertible Note offers two features attractive to investors and absent in the SAFE, namely an interest rate and a maturity date. 

    • The interest rate means investors get the benefit of a guaranteed annual rate return in connection with their investment in the Convertible Note.  The interest may simple or compounding, but either way, this is a clear advantage for investors, when compared with the SAFE, which does not include an interest rate.  The obvious benefit here is that, whether upon the Maturity Date or prior conversion event, the Convertible Note Investor is guaranteed either more cash or shares due to the accrued interest.
    • Perhaps more important to investors, the Convertible Note includes a maturity date (typically about a year), which technically means that in the absence of a Priced Round being consummated prior to the Maturity Date, the Purchase Amount plus accrued interest becomes due and payable by the Company to the Investor.  In reality, the Maturity Date serves the function of a point of leverage for the Investor who can demand more favorable terms in exchange for agreeing to extend the Maturity Date.  The SAFE note contains no such deadline for a return of capital or option to renegotiate terms.  In the absence of Priced Round or Liquidity Event, the SAFE note holder has no choice but to stand on the sidelines hoping for a Priced Round to trigger conversion of its SAFE.

  2. The Convertible Note may contain an optional conversion feature, permitting the Investor to demand conversion of the Convertible Note under certain circumstances.  The SAFE does not normally include any such term.

  3. As a debt instrument, the Convertible Note will entitle the Investor holding such note to preference over all equity holders, including both founders and SAFE holders upon a sale of the Company or other Liquidity Event.  That is, debt obligations (e.g. Convertible Notes) are always paid out first in priority to equity holders in connection with a Liquidity Event.

Are SAFEs better than convertible notes? 

In an effort to simplify the comparison of the Convertible Note and the SAFE Note, the following chart summarizes the primary features of each and identifies whether differences favor the investor or the company.

FeatureConvertible NoteSAFEDifference Favors
Non-Priced RoundYesYesNeither
Conversion “Cap” OptionYesYesNeither
Conversion Discount Option?YesYesNeither
Optional ConversionYesNoInvestor
Simplicity/SpeedPotentially more complex/slowerPotentially simpler/fasterCompany, perhaps
CostPotentially more expensivePotentially less expensiveCompany, perhaps
Maturity DateYesNoInvestor
Interest RateYesNoInvestor
Liquidation PreferenceDebt paid before equityEquity-equivalents paid after debtInvestor

As discussed above, while the SAFE and Convertible Note are both relatively simple and effective funding instruments commonly utilized in connection with the friends and family round, the two should not be viewed as entirely interchangeable.  The SAFE may not quite live up to its founding principles of minimal cost and simplicity, but provides an appealing alternative for founders of early-stage companies. On the other hand, the distinctive features of the Convertible Note make it the more desirable choice for investors.


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