The date of conversion is not predetermined, but it can happen when an equity round is raised and preferred shares are distributed.
Conversion to equity: Investors can change their investment to equity later. There are provisions for investors, such as discounts and valuation caps. Similar provisions: SAFE notes still make provision for early exits, change of control, or even the dissolution of a company. 
Accounting: Like other convertible securities, SAFE notes end up on a company's capitalization table. Sometimes valuation caps are talked about, but that's all. Less to negotiate: Unlike other investments, SAFE notes do not require much negotiation. It will be straightforward with clear perks and downsides. You may even be able to understand and draft one without a lawyer's help. It has no end date or interest and is only a five-page document. Simplicity: A SAFE note is simpler than a convertible note. To decide whether SAFE notes are for you, take some time to weigh the pros and cons. When seeking seed money, it's typically best to choose the option that is most popular in your community so investors will feel comfortable. However, even an exceptionally low interest rate adds up over time when pressed into a conversion formula, so it's advantageous to investors to include an interest rate in a convertible note.īoth SAFE notes and convertible notes are good options, and there are good reasons to use either. Even with convertible notes, interest is rarely negotiated. With SAFE notes, investors could be waiting endlessly for maturity even once the business is turning a profit. An end date can force a conversion to equity and provide a right to equity conversion via the valuation cap. Since SAFE notes are not a debt instrument, there is no maturity or end date. Going without a qualifying transaction obligation can help since this would prohibit a conversion to real equity. However, SAFE notes can convert with any dollar amount in a preferred cycle. For a convertible note, a minimum amount must be raised in the round before it can convert. It is possible for a note to change into equity during a future round of financing. A reputable lawyer at UpCounsel can help you decide which option is appropriate for you. Some people do find ways to use SAFE notes with an LLC, but it's not simple. On the other hand, SAFE notes require C-Corp status because the investment is noted on a capitalization table just like stock options. A limited liability company can use a convertible note, since that kind of note is a debt instrument. Sometimes, a startup is a limited liability company, not a C-corporation. Alternatively, if they stay with the acquisition, they can have a 1x payout or equity according to the valuation cap. Often, if there is a change of control, convertible note templates will give a 2x payout option as well as an equity conversion. However, it is not common for either to be absent, as that would discourage investors.Įarly exit payback means that notes can be paid out to the buyer if an acquisition or change of control should occur prior to the regularly expected conversion. 
SAFEs can include a discount, a valuation cap, both, or neither. At the time of conversion, the investor can take advantage of either the discount or the valuation cap - whichever is more favorable. A valuation cap sets the highest price that can be used to set the conversion price. The following are some general terms and considerations to be aware of.Ĭonvertible securities typically include a discount that can be applied to the future valuation when it's time to convert. Seed Investments: General Termsīoth convertible notes and SAFE notes are convertible securities, which means they can eventually be converted to equity. However, SAFE notes do have some shortcomings that can cause entrepreneurs to pay a high price. Startups may prefer SAFE notes because, unlike convertible notes, they are not debt and therefore do not accrue interest.
It addresses many of the drawbacks and challenges posed by convertible notes and can be an equitable option for investors and founders. The valuation caps are the only negotiable detail.Ī SAFE note is a convertible security that, like an option or warrant, allows the investor to buy shares in a future priced round. They were created in 2013 by Y Combinator, a Silicon Valley accelerator, and allow startups to structure seed investments without interest rates or maturity dates. SAFE (simple agreement for future equity) notes are a simpler alternative to convertible notes. Updated June 19, 2020: What Are SAFE Notes?
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