SAFE Note vs. Convertible Note: The Differences

As a startup, you have several options for raising capital. Two of them include SAFE notes and convertible notes, both of which are good options for businesses that are in early stage development. 

Both of these allow you to push the valuation of your business to a later date so that you can grow the business (and support a higher valuation) before setting the valuation on which to sell equity. This, of course, helps you sell less equity because you increase the value per share before selling shares.

While SAFE notes and Convertible notes are similar in nature, there are several differences between them that are important to understand. So how do SAFE notes and convertible notes work and which one is right for your business? Keep reading to find out. 

What is a SAFE?

SAFEs or Simple Agreement for Future Equity notes were initially created in 2013 by Silicon Valley startup accelerator, Y Combinator. While SAFE notes are designed to be converted to equity at a later date, they are not considered loans or debt instruments. Therefore, they don’t have an interest rate or predetermined maturity date. As a result, there is no pressure for your business to convert a SAFE note into equity at a particular date or during a round of fundraising. 

• Discount Included; Valuation Cap Included: This version is one of the more frequently used types because it offers two incentives for the SAFE investors. The investors are guaranteed to get extra value when the SAFE converts to equity. If the SAFE converts above the valuation cap, the SAFE investors buy in at the lower dollar per share established by the valuation cap. If the SAFE converts below the valuation cap or if the discount provides a better price, the SAFE investors buy in at the lower dollar per share established by the discount.
• No Discount; Valuation Cap Included: This version makes sense if you want to provide your investors with the benefit of a valuation cap, but do not want to include a discount option (which is used if the SAFE converts below the valuation cap).
• Discount Included; No Valuation Cap: This version of the SAFE note removes the valuation cap, but provides SAFE investors with a discount upon conversion. This is another way to guarantee that your SAFE investors get extra value upon conversion.
• No Valuation Cap; No Discount: This version is rare as it offers no incentive for investors and is, therefore, harder to sell. However, it is the best fit for the purpose of minimizing dilution.

Convertible notes may also include a valuation cap which sets the ceiling on the valuation of the company for purposes of conversion. Said another way, these investors set a upper limit on the price they are willing to pay for each share of the company.

Here’s a brief overview of how they both work: An investor agrees to give your business a certain amount of money today. In exchange, they receive the right to convert those funds into shares of your company. Typically, the monies convert at a better rate (aka, better dollar per share) than the new equity being sold.

Differences Between SAFES and Convertible Notes 

While SAFEs and convertible notes have similar functions, there are several noteworthy differences between them, including:

• Debt Classification: SAFE notes are not classified as debt instruments whereas convertible notes are. Put simply, convertible notes are loans that must be repaid through cash or company shares.
• Interest: Just like most debts, convertible notes come with interest charges. Your business will need to repay the principal plus interest. SAFE notes, however, don’t carry interest because they serve as agreements or warranties rather than debts.
• Timelines: Unlike SAFE notes, convertible notes have a maturity date. After about 18 to 24 months, a convertible note usually converts automatically or must be repaid. If your business doesn’t continue to raise money, SAFE notes can be held. 
• Documentation: Compared to convertible notes, SAFE notes are usually shorter and more straightforward. This is because there are less terms and contingencies for your business and investors to agree on. In addition, convertible notes almost always require a separate note purchase agreement (to sign before monies are exchanged) while SAFEs do not typically require such pre-documentation.
• Flexibility: SAFEs are based on standardized templates you can find on Y Combinator’s website. Since convertible notes are not as standardized, they may allow for greater flexibility for your business and investors, but they also require more legal support to produce.

Are SAFES Better than Convertible Notes?

Bottom Line

Whether a SAFE note or convertible note is best for your business depends on your specific circumstances. While a convertible note is more flexible in its terms, a SAFE note has greater simplicity. Need help choosing the best for you? Contact GrowthLab today!