SAFE Notes vs Convertible Notes: A Founder's Guide

# SAFE Notes vs Convertible Notes: A Founder's Guide

You're raising your seed round, and your investors keep throwing around terms like "SAFE note" and "convertible note" as if they're obvious choices. They're not. And the difference between them could significantly impact your company's future ownership structure and flexibility.

In our work with early-stage founders at Inflection CFO, we've seen far too many entrepreneurs sign documents they don't fully understand, only to face complications when it's time to raise a Series A or navigate a liquidation event. The good news? Understanding the SAFE vs convertible note distinction isn't complicated once we break it down.

Let's walk through what these instruments actually are, when to use each one, and the specific terms that should keep you up at night.

## What Is a Convertible Note?

A convertible note is a debt instrument—think of it as a loan that can transform into equity. Here's how it works:

**The Structure:**
An investor gives you cash in exchange for a note (essentially an IOU) that specifies:
- A principal amount (how much they invested)
- An interest rate (typically 3-8% annually)
- A maturity date (usually 2-3 years from issuance)
- A conversion mechanism (how debt becomes equity)

**The Conversion Mechanics:**
Your convertible note converts to stock when one of three things happens:

1. **Qualified Financing Event** - You raise a Series A or later institutional round. The note converts at a discount (typically 20-30%) to the Series A price, rewarding early investors for taking risk.

2. **Maturity** - If you haven't raised a qualified round by the maturity date, the note becomes a real debt that needs to be repaid. (This rarely happens cleanly and creates headaches.)

3. **Acquisition or Liquidation** - The note either converts to equity or gets repaid ahead of other obligations.

**A Real Example:**
You raise $500,000 in convertible notes at 6% interest with a 20% discount and 3-year maturity. Two years later, you close a Series A at $5 per share. The note converts at a 20% discount ($4 per share), meaning your early investor gets 125,000 shares instead of 100,000.

## What Is a SAFE Note?

A SAFE (Simple Agreement for Future Equity) is a newer instrument created by Y Combinator in 2013. Here's the critical distinction: **a SAFE is not a debt instrument.** It's a contract promising future equity, not a loan.

**The Structure:**
A SAFE specifies:
- An investment amount
- A valuation cap (or discount, or both)
- Triggering events (typically a Series A or acquisition)
- That's it. No interest. No maturity date. No principal repayment obligation.

**The Conversion Mechanics:**
Your SAFE converts to stock only when a triggering event occurs:

1. **Equity Financing Event** - You raise a priced round (Series A). The SAFE converts at the lesser of the valuation cap or a discount to the Series A price.

2. **Acquisition** - You get acquired. SAFEs typically convert at the purchase price or follow a predefined formula.

3. **IPO** - You go public. The SAFE converts to common stock.

**A Real Example:**
You raise $500,000 in a SAFE with a $5 million valuation cap. Two years later, you close a Series A at $10 million valuation ($10 per share). Your SAFE holder converts at the cap price of $5 million / shares outstanding. If you issued 250,000 shares in your Series A, your SAFE holder converts at roughly $5 per share (versus the $10 market price), receiving 100,000 shares.

## Key Differences: SAFE vs Convertible Note

Here's the breakdown that matters most:

| Aspect | Convertible Note | SAFE |
|--------|-----------------|------|
| **Type** | Debt instrument | Equity commitment |
| **Interest Rate** | Yes (3-8% typical) | No |
| **Maturity Date** | Yes (2-3 years typical) | No |
| **Repayment Obligation** | Yes, if no conversion | No |
| **Conversion Trigger** | Qualified financing, maturity, or exit | Series A, acquisition, or IPO |
| **Valuation Setting** | Discount to Series A price | Valuation cap (and/or discount) |
| **Investor Preference** | Senior to equity, junior to debt | Typically no liquidation preference |
| **Founder Complexity** | More complex, more founder protection | Simpler, less upfront negotiation |
| **Cap Table Impact at Series A** | Can create messy debt-to-equity math | Cleaner conversion |

The philosophical difference: convertible notes are a compromise (part loan, part equity play), while SAFEs assume you'll raise a priced round and are purely a placeholder until that happens.

## When to Use Convertible Notes

We recommend convertible notes in these scenarios:

### 1. **You Have Uncertainty About Series A Timing**
Convertible notes have a maturity date. If your Series A might be 3+ years away (or might not happen), a convertible note creates urgency and a fallback mechanism. The maturity date forces a decision: convert, extend, or repay.

### 2. **You're Raising From Sophisticated Investors**
VCs, angel syndicates, and experienced investors expect convertible notes. They understand the mechanics, have standard templates (like the YC SAFE or 500 Startups' post-money SAFE), and negotiate efficiently.

### 3. **Interest Rate and Discount Matter to Your Cap Table**
If you're raising multiple seed rounds from different investors at different times, the interest accrual and discount stacking in convertible notes can be advantageous. It rewards early investors more generously than SAFEs.

### 4. **You Want Debt-Like Tax Treatment (Rare)**
In rare cases, if the debt-like structure matters for accounting or tax purposes, convertible notes offer that. Most startups don't care about this.

## When to Use SAFEs

We recommend SAFEs in these scenarios:

### 1. **You're Building Momentum Quickly**
SAFEs close faster because there's less to negotiate. No interest rate debates, no maturity date haggling. You and the investor agree on a valuation cap, both sign in a few days. We've seen founders close SAFEs in a week where convertible notes took four.

### 2. **You're Raising Small Checks From Non-Traditional Investors**
If you're raising from friends, family, or micro-VCs ($25K-$100K checks), SAFEs are simpler to explain and execute. Fewer moving parts mean fewer surprises later.

### 3. **You're Certain About a Series A in 18-24 Months**
If your trajectory suggests you'll raise a priced round soon, the maturity date complexity of convertible notes is unnecessary. SAFEs are cleaner in this case.

### 4. **You Want Simplicity Now, Not Complexity Later**
SAFEs have far fewer negotiation surface areas. One conversation about valuation cap, done. Convertible notes? You're debating interest rates, maturity dates, qualified financing definitions, and pro-rata rights.

## Critical Terms to Negotiate

Whether you choose SAFEs or convertible notes, these terms will impact your future equity significantly.

### **Valuation Cap (Both Instruments)**
The valuation cap sets the maximum price at which your SAFE or convertible note will convert. It's your early investor's protection against you raising at a higher valuation later.

**Founder consideration:** A lower cap is better for early investors, worse for you. A $5M cap on a note that converts in a $15M Series A looks great for the early investor (they get a massive discount), but it dilutes your ownership more.

**What's reasonable?** For pre-revenue or early traction startups, $3M-$8M caps are common. For startups with strong traction or revenue, $10M-$25M is typical.

### **Discount (Both Instruments)**
The discount is an additional incentive for early investors beyond the valuation cap—they convert at X% below the Series A price, usually 15-30%.

**Founder consideration:** Discounts stack across multiple SAFEs/notes, which can create significant dilution when you have 3-4 seed investors. A 20% discount to each of five investors means each gets a meaningful head start on their equity.

### **Interest Rate (Convertible Notes Only)**
Typical range: 3-8% annually. This compounds on the principal, so a $500K note at 6% for 3 years becomes $596K principal at conversion.

**Founder consideration:** The interest compounds on conversion to equity (in some terms) or accrues as additional debt. Either way, it's dilution you didn't anticipate. Push for 3-4%. Anything above 8% is excessive for a startup.

### **Maturity Date (Convertible Notes Only)**
When the note "matures" and technically becomes a real debt. Typical: 2-3 years.

**Founder consideration:** A 2-year maturity forces a Series A decision earlier. A 3-year maturity gives more breathing room but creates uncertainty if you're still fundraising at year 3. In practice, maturity date drama is rare (most notes convert before maturity), but it happens.

### **Pro-Rata Rights (Negotiable)**
Does your SAFE/note investor have the right to participate in future rounds to maintain their ownership percentage?

**Founder consideration:** This is subtle but important. If you grant pro-rata rights to every seed investor, by Series A you might have 10+ people claiming the right to invest again, complicating your round. We typically limit pro-rata rights to checks above $100K.

## The Founder Implications You Need to Know

### **Cap Table Cleanliness**
SAFEs create a cleaner cap table. They convert in one step. Convertible notes, especially multiple ones from different rounds, create multiple conversion events with stacked discounts and interest. By the time you close a Series A, you're explaining complex conversion math to your new investors.

### **Series A Complications**
We've sat in Series A diligence meetings where convertible notes created unexpected issues: investors questioning the interest accrual, disputing what counts as a "qualified financing," or discovering that multiple discounts stacked to reduce founder ownership more than expected. SAFEs are simpler here.

### **Extension and Amendment Risk**
With convertible notes, maturity dates can create urgent conversations. "Our note is maturing in 60 days—do we extend, convert, or refinance?" We've seen founders distracted by this admin work when they should be focused on product. SAFEs eliminate this risk.

### **Acquisition and Liquidation Scenarios**
If you get acquired for less than the valuation cap on your SAFE, the conversion terms matter deeply. Most SAFEs convert to equity at acquisition, meaning your early investors own meaningful pieces of the deal. Convertible notes typically get paid off as debt, which can be advantageous depending on the deal structure. Get clarity on this before signing.

## SAFE vs Convertible Note: The Decision Framework

Here's how we counsel our clients:

**Choose a convertible note if:**
- You're raising from institutional investors (VCs, angel syndicates)
- You're uncertain about Series A timing
- You have multiple seed rounds and want clear investor incentive differentiation

**Choose a SAFE if:**
- You're raising from friends, family, or micro-investors
- You want a fast closing process
- You're confident about a Series A within 18-24 months
- You want minimal cap table complexity

**Our honest take:** For most early-stage founders we work with, SAFEs are the better choice. They're simpler, they close faster, and they create fewer future headaches. The additional complexity of convertible notes rarely pays off unless you have a specific reason to want it.

## Getting the Documents Right

Whether you choose SAFEs or convertible notes, use standard templates. Y Combinator publishes free SAFE documents. The Series Seed documents and 500 Startups templates are also solid. Don't negotiate your own custom documents from scratch—it's expensive and usually unnecessary.

The three things worth negotiating:
1. Valuation cap
2. Discount
3. Pro-rata rights (if any)

Everything else in the template is fine as-is.

## Building Your Fundraising Strategy

As you move from seed to Series A, understanding your capitalization structure becomes critical. We recommend tracking your SAFEs and convertible notes in a detailed model so you understand exactly how they'll convert and what your ownership percentage will be post-Series A. [How to Build a Startup Financial Model: A Step-by-Step Guide](/blog/how-to-build-a-startup-financial-model-a-step-by-step-guide/) walks through this modeling in detail.

When you're ready to think about Series A, you'll also want to understand the diligence process. [Series A Preparation: The Financial Due Diligence Playbook](/blog/series-a-preparation-the-financial-due-diligence-playbook/) covers what investors will scrutinize about your cap table and how to prepare.

## Final Thoughts

SAFE notes and convertible notes both solve the same core problem: how to take investor money before you've determined a priced valuation. The SAFE is simpler and newer; the convertible note is more complex and more familiar to institutional investors.

There's no universally "right" choice—it depends on your situation, your investors, and your timeline. But in our experience, founders who opt for SAFEs spend less time managing cap table complexity and more time building their business. And that's the real goal.

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**Ready to get your seed round right?** At Inflection CFO, we help founders think through fundraising strategy, cap table modeling, and the financial implications of different funding structures. If you're in the middle of a seed round and want to audit your approach, [reach out for a free financial strategy consultation](/contact). We'll review your term sheet, model your cap table, and make sure you're not leaving value on the table.