SAFE Note VS Convertible Note: The Differences

For startup companies, raising funds can be a crucial step in achieving success. Two common instruments used by startups to raise capital are the SAFE note and the convertible note. While both of these instruments are debt-like, there are significant differences between them. In this blog post, we will explore the differences between SAFE notes and convertible notes.

What is a SAFE Note?

SAFE stands for Simple Agreement for Future Equity. A SAFE note is a financial instrument used to raise capital for early-stage startups. It is similar to a convertible note in that it is a debt-like instrument that converts to equity in the future. However, unlike a convertible note, a SAFE note does not have an interest rate or a maturity date.

Instead, a SAFE note provides the investor with the right to convert their investment into equity at a future date, typically when the company raises its next funding round. At that point, the investor receives equity in the company, typically at a discount to the price paid by the next round of investors.

What is a Convertible Note?

A convertible note is also a financial instrument used to raise capital for early-stage startups. It is a debt-like instrument that converts to equity in the future, typically at the next funding round. Unlike a SAFE note, a convertible note has an interest rate and a maturity date, which means that it must be repaid if it is not converted to equity.

The interest rate on a convertible note is typically lower than the market rate for debt, reflecting the fact that the investor is taking on a higher risk. The maturity date is typically 18 to 24 months after the investment is made, giving the startup time to raise its next funding round.

Differences between SAFE Notes and Convertible Notes

There are several key differences between SAFE notes and convertible notes. These include:

1. Interest Rate and Maturity Date: As noted above, a convertible note has an interest rate and a maturity date, while a SAFE note does not.
2. Valuation: A SAFE note typically does not include a valuation cap or a discount rate, which means that the investor is not guaranteed a minimum return on their investment. A convertible note, on the other hand, typically includes both a valuation cap and a discount rate, which provide some protection for the investor.
3. Repayment: A convertible note must be repaid if it is not converted to equity, while a SAFE note does not have to be repaid.
4. Dilution: A SAFE note can result in greater dilution of the founder’s ownership stake because the investor’s equity is typically priced at a discount to the next funding round. With a convertible note, the investor’s equity is typically priced at the same price as the next funding round, which can result in less dilution for the founder.

In conclusion, both SAFE notes and convertible notes are useful financial instruments for raising capital for early-stage startups. However, there are significant differences between the two, particularly with respect to interest rates, maturity dates, valuations, repayment, and dilution. As with any financial instrument, it is important for both the startup and the investor to understand these differences and choose the instrument that best meets their needs.

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