SAFE vs Convertible Notes: Which is Better for Your Next Round?

Key takeaways

• SAFEs are faster and simpler to administer than convertible notes with no interest or repayment deadlines, making them ideal for early-stage fundraising.
• Convertible notes offer more structure and investor protections, such as interest rates and maturity dates, which are best suited for bridge rounds or when working with institutional investors.
• Both instruments dilute ownership, but convertible notes typically cause more dilution due to interest accumulation. SAFEs offer cleaner cap table modeling and more predictable equity conversion.

What is a SAFE?

A SAFE, or Simple Agreement for Future Equity, is a fundraising instrument created by Y Combinator to simplify early-stage funding. 

Unlike convertible notes, SAFEs are not debt instruments. They don’t:

• accrue interest
• have a maturity date, or 
• carry the legal risk of needing repayment. 

It is more founder-friendly and has minimal legal complexity, making it perfect for early rounds when speed and simplicity are crucial.

Instead of offering immediate equity or taking on debt, founders issue SAFEs to investors as agreements that convert into shares later, usually during a future priced round.

How does a SAFE work?

The number of shares an investor receives depends on the terms of the SAFE, such as a valuation cap, a discount, or both. 

A valuation cap sets the maximum company valuation at which the SAFE will convert, giving early investors more shares if the company’s valuation has crossed that threshold. A discount allows them to buy shares at a lower price than new investors in that round.

SAFEs can be structured as pre-money or post-money, depending on how ownership dilution is calculated. 

Pre-money SAFEs convert based on the company's valuation before new capital is added and before other convertibles are taken into account. Post-money SAFEs, on the other hand, calculate ownership after all SAFEs and other convertibles have been converted.

What is a convertible note?

A convertible note is a debt instrument used to raise funds, with the intention of converting that debt into equity during a future priced funding round.

Unlike SAFEs, which are purely contractual agreements for future equity, convertible notes are legally treated as loans until they convert.

Convertible notes often include valuation caps and discounts, similar to SAFEs. However, it comes with interest rates (commonly 4–8%) and a maturity date, after which the note may need to be repaid if it hasn't already been converted.  

Startups may choose convertible notes when they want a more formal, time-bound agreement that encourages them to raise a priced round within a specific period. 

How do convertible notes work in startup funding?

During conversion, a convertible note's principal amount, along with any accrued interest, is converted into shares of the company. If the company doesn’t raise a priced round before the note’s maturity date, the investor may either convert the note manually at a negotiated valuation or choose to extend its term.

Note: Investors prefer convertible notes because the debt structure provides them with more control and legal protection if the startup fails to meet its growth expectations.
1. If assets are liquidated, noteholders are repaid before common shareholders.
2. Convertible notes typically come with a maturity date and an interest rate, which legally obligates the company to repay the principal plus interest

SAFEs vs convertible notes: A detailed breakdown

1. Maturity pressure

SAFEs don’t have a maturity date. There’s no deadline for conversion, which gives founders the flexibility to grow at their own pace.

Convertible notes, on the other hand, come with a fixed maturity date, often 18 to 36 months. If no priced round occurs before that time, the investor may demand repayment or force a conversion. It can create pressure on the founders to raise under suboptimal conditions just to meet the deadline.

2. Interest and accrued risk

SAFEs don’t accrue interest at all. Since they’re not considered debt, there’s no compounding obligation tied to time. This makes SAFEs a cleaner option for startups that need capital now but don’t want their equity cost to increase the longer it takes to raise their next round.

Convertible notes accrue interest over time, which is added to the principal when calculating the investor's equity stake. Unless explicitly stated otherwise in the agreement, this interest is not paid out in cash.

Why are interest rates important?

Let’s say an investor gives $200,000 on a convertible note with a 7% interest rate and a 1-year maturity. If the company doesn’t raise a priced round within a year, it would need to repay $214,000 ($200,000 principal + $14,000 interest). 

If the note instead converts to equity, the founder would face additional dilution equivalent to $14,000.

Note: If both parties agree to push back the maturity date, they can update the terms of the note through mutual agreement.

3. Investor power and negotiation leverage

SAFEs typically come with fewer demands, allowing founders to retain more strategic control. However, convertible notes give investors more control, especially if the company struggles or delays a priced round.

For example, if the company is struggling or delays a priced round, noteholders can renegotiate terms, demand repayment, or convert into equity on less favorable terms to the company. 

What about MFN clauses?

Some SAFEs include a Most Favored Nation (MFN) clause. This means that if future SAFE investors receive better terms, such as a lower valuation cap or a larger discount, early investors have the right to adopt those favorable terms.

4. Valuation caps and discounts

Both SAFEs and convertible notes include valuation caps and discounts, two investor-friendly terms.

A valuation cap sets the maximum valuation at which the investor’s money will convert during the next financing round. A discount, on the other hand, allows investors to convert at a lower price per share than the new investors.

These tools reward early investors for taking early risk.

Choose valuation cap or discount, not both

Although some SAFEs include both, it's generally not advised. These mechanisms serve different purposes, and combining them can feel unfair to founders. Y Combinator specifically recommends using one or the other, not both, and no longer provides a combined version in their templates.

“YC’s recommendation to founders was to issue either the valuation cap flavor, safe, or the discount flavor. We did not encounter situations where the combo safe was the preferred choice. Accordingly, we decided it was incongruous to make this version available.” – Y Combinator “Website User Guide”, 2023

5. Tax and legal treatment

For startups, SAFEs generally do not create taxable income when issued. They don’t owe taxes when they receive SAFE investments, because it's not considered revenue or a loan. However, improper compliance can result in penalties or audit risks. Therefore, it's advisable to seek professional help and ensure compliance is correct.

Convertible notes are generally treated as debt, so funds received are not taxable income at issuance.

Interest that accrues on the note can typically be deducted as a business expense, reducing taxable income.

However, if the accrued interest is later converted into equity, any interest deductions previously claimed may have to be reversed, effectively increasing taxable income, depending on the note’s terms and timing.

409A valuation impact

Startups don’t need a 409A valuation to issue SAFEs or convertible notes.

However, both SAFEs and convertible notes can influence your 409A valuation. If many are outstanding, especially with low valuation caps, they can affect your 409A later, as valuation firms may treat them as economic dilution.

This reduces option strike prices and is risky if not updated before a funding round, acquisition, or key stock grants.

When to use a SAFE vs convertible note

Deciding between a SAFE and a convertible note depends mainly on your startup's stage, fundraising goals, and the type of investors you're engaging with. Neither is inherently "better," but rather more suitable for different scenarios. 

The goal is to match it with your funding timeline and level of negotiation flexibility.

Choose a SAFE if:

• You’re raising a pre-seed or early seed round from angels or accelerators.
• You want fast and simple fundraising with minimal legal complexity.
• You don’t expect a priced round within the next 12 months or more.
• You want to avoid accruing interest and meeting maturity deadlines.
• You prefer cleaner cap table planning with predictable dilution.

Choose a Convertible Note if:

• You’re raising a bridge round to fund operations until your next priced equity round in the near future.
• Your investors prefer structured terms with interest and repayment triggers.
• You’re working with traditional or institutional investors familiar with debt instruments.
• You’re comfortable with the potential obligation to repay if no priced round occurs.

SAFEs vs convertible notes: Founders’ common mistakes

When dealing with SAFEs and convertible notes, here are some of the most frequent pitfalls to avoid:

1. Not modeling dilution scenarios

‍Many founders sign multiple SAFEs or convertible notes without understanding how they’ll stack up during a priced round. It may result in unexpected dilution and a surprise loss of ownership.

2. Ignoring maturity triggers on notes

‍Convertible notes have deadlines. If you miss the maturity date without raising a priced round or repaying, you could face default obligations to repay the principal amount plus interest.

3. Forgetting investor psychology

‍Not all investors view SAFEs and convertible notes the same way. Some prefer the structured terms and control that convertible notes provide, while others dislike the concept of a young startup carrying legal debt. Misunderstanding these preferences can hinder your fundraising progress or deter ideal partners.

SAFE vs convertible note - Can you use both?

Yes, hybrid rounds that combine SAFEs and convertible notes are possible, depending upon the individual investor's needs. But founders need to be intentional about how these instruments stack and convert.

1. Handling conversions‍

Both SAFEs and convertible notes convert into equity during a priced round. But notes may convert earlier if a maturity date hits, or if interest accumulates beyond what’s reasonable. To avoid chaos on your cap table, set clear conversion triggers and track instruments with different terms separately.

2. Investor friction‍

Mixing SAFEs and notes with different caps, discounts, or timelines can lead to unnecessary friction. One investor may convert at a $5M cap, while another may convert at $8M, even if they invested the same amount. This disparity can create friction, especially if you’re not transparent about who gets what.

3. Documentation‍

Using both instruments is fine, as long as your documents, models, and investor communications are airtight. Keep detailed records of cap tables, conversion logic, and pro-rata rights.

Simplify your SAFE vs convertible note management with EquityList

Managing multiple SAFEs and convertible notes across rounds can quickly get complicated, especially when you're preparing for a priced round. 

EquityList lets you manage various fundraising instruments such as SAFE or Convertible Debt. Our platform stores the conversion terms in structured (i.e. fields like valuation cap, discount, maturity date) and unstructured forms (like the raw legal documents) so that companies know when the instruments will convert and the impacts. Use EquityList to:

• Track all your SAFEs and convertible notes in one centralized dashboard.
• Model dilution scenarios based on valuation caps, discounts, and interest accrual.
• Maintain clean ownership records with built-in investor reporting tools.

Trusted by over 450 companies, including Cars24, Slice, and Shiprocket, Tabby, Bajaj, we manage more than $3 billion in options. Reach out to us and get started with your founder-friendly fundraising stack.

FAQs

1. Is a SAFE better than a convertible note for early-stage startups?

A SAFE is generally better for early-stage startups, as it offers faster, simpler fundraising with no interest or maturity date. It’s more founder-friendly and doesn’t impose the debt obligations of convertible notes. However, convertible notes may be preferred by investors who seek more structured terms.

2. Do SAFEs dilute ownership?

Yes, SAFEs do dilute ownership when they convert into equity during a priced round. The amount of dilution depends on the valuation cap, discount, and the terms of the SAFE agreement.

3. What happens if a convertible note matures before a priced round?

If a convertible note matures before a priced round, the startup may be required to repay the principal with interest or convert it into equity at a pre-agreed conversion price.

4. Can I raise using both SAFEs and convertible notes?

Yes, you can raise using both SAFEs and convertible notes in the same round, but it requires careful structuring to avoid confusion or friction among investors. It’s crucial to have clear conversion triggers and maintain transparency regarding terms.

5. Are SAFEs considered debt?

No, SAFEs are not considered debt. They are equity instruments that convert into shares in a future priced round, unlike convertible notes, which are debt instruments that accrue interest and have a maturity date.