SAFE vs Convertible Note: The Battle of Convertible Securities for Startups‍

Casey Fenton

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January 8, 2024

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Picture this: you're an entrepreneur with a revolutionary idea that's poised to disrupt an industry. You've spent countless hours refining your business plan, assembling a top-notch team, and preparing to take the leap into the startup world. But there's a hurdle: funding. 

As you consider your funding options, you encounter two intriguing routes: the SAFE note and the convertible note. Both offer a lifeline of financial support, but their approaches couldn't be more distinct. In this article, we'll uncover the practicalities of each instrument and help you navigate the critical decision of whether to embrace the SAFE note's flexibility or the convertible note's structure.

What are Convertible Securities?

Convertible securities are financial instruments that provide a bridge between early-stage funding rounds and a more mature valuation of the startup. They allow investors to contribute capital to a startup at an earlier stage, while the valuation is still uncertain, in exchange for the promise of future equity.

Why Choose the Convertible Route Over Equity Funding

One primary factor is the timing. Early-stage startups often grapple with the challenge of determining a precise valuation. Going the equity funding route requires putting a stake in the ground, potentially leading to complex negotiations and delays. However, convertible securities offer a workaround by deferring the valuation discussion to a later date, allowing you to focus on building your business with the immediate injection of capital.

Moreover, consider the evolving nature of your startup's value. In these nascent stages, your business's potential might be crystal clear to you, but pinpointing its exact value remains elusive. Opting for convertible securities acknowledges this reality, providing a pragmatic solution. By doing so, you're inviting investors to join you on this exciting journey without the baggage of hammering out a valuation before your business has truly taken flight.

The flexibility of convertible securities aligns well with the early challenges of your startup. You're likely navigating uncharted territory, making frequent pivots, and adapting to new insights. Unlike equity funding, convertible securities offer a more adaptable structure that grows with your startup. This adaptability is a valuable asset, allowing you to respond to market shifts and investor dynamics without being bound by fixed terms.

In other words, choosing the convertible route over equity funding boils down to pragmatism and adaptability. It allows you to secure funding when you need it most, without getting bogged down in the complexities of valuation negotiations. This flexibility, coupled with your startup's innate dynamism, creates a symbiotic relationship that could prove instrumental in propelling your vision toward success.

What is a SAFE Note?

A SAFE Note is an innovative instrument designed with efficiency and simplicity in mind. Unlike the conventional convertible note, a SAFE (Simple Agreement for Future Equity) Note forgoes the intricacies of interest rates and maturity dates, streamlining the investment process.

Here's how it works: as a founder, you and your investor agree on an investment amount. In return, the investor receives a promise—the option to convert that investment into equity during a subsequent funding round. This stripped-down approach to investment agreements has its advantages. The absence of an interest rate removes the complexity of calculating interest accruals over time, ensuring a straightforward arrangement for both parties involved.

Furthermore, the lack of a maturity date is a distinctive feature of the SAFE Note. Unlike convertible notes, which carry a predefined expiration date, SAFE Notes do not impose a timeline for conversion. This means you're free from the pressure of adhering to specific deadlines, allowing your startup to evolve naturally and find the right moment to trigger the conversion.

The simplicity of a SAFE Note extends to its documentation. With fewer terms and conditions to negotiate, legal processes are often streamlined, saving both time and resources. This minimalist approach can be particularly attractive for startups seeking swift funding without the bureaucratic hurdles that sometimes accompany more complex investment instruments.

Hence, SAFE Note presents a no-frills approach to raising capital. It aligns with the fast-paced nature of the startup world, providing a mutual understanding between you and your investor without the burden of interest calculations and firm maturity dates.

What is a convertible note?

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A convertible note is a financial instrument that bridges the gap between early-stage funding and subsequent valuation rounds. When you opt for a convertible note, you're inviting investors to lend their support while deferring the valuation conversation to a later date. This can be a strategic move, especially when your startup's valuation is still in flux.

One hallmark feature of the convertible note is the inclusion of an interest rate. This rate accumulates over time, progressively growing the principal investment. When the maturity date arrives, this interest is factored into the conversion equation. This interest-driven structure can be advantageous for investors, as it ensures a return on their investment regardless of whether the startup proceeds with a valuation round or not.

Another defining characteristic of convertible notes is their adherence to a predetermined maturity date. This date, often set within a range of 1 to 3 years, acts as a ticking clock. If your startup hasn't initiated a subsequent funding round by this date, the convertible note matures. This pivotal moment necessitates a decision – either the investor receives their principal back, along with any accrued interest, or the note converts into equity at a pre-established valuation.

In contrast to the streamlined nature of a SAFE Note, convertible notes encompass a more structured framework. They lay out the terms and conditions in greater detail, offering a comprehensive understanding of how the investment will unfold over time. This structured approach can be particularly appealing to investors who seek a more established framework for their investments.

SAFE vs Convertible Note: A Side-by-Side Comparison

Valuation Caps and Dilution

A SAFE note typically comes with a valuation cap, which sets the maximum price at which the investment converts into equity. This can protect early investors from excessive dilution. convertible notes may also include a valuation cap, but they often come with a discount rate that encourages early investment without a specific cap.

Interest Rates

convertible notes come with an interest rate, meaning the principal investment grows over time. This interest is usually added to the conversion amount upon maturity. SAFE notes, as mentioned earlier, do not carry an interest rate, simplifying the financial arrangement for both parties.

Early Exits

In the case of an early exit (such as an acquisition), both SAFE notes and convertible notes provide mechanisms for investors to convert their investments into equity or receive their principal back with a predetermined interest. However, SAFE notes might be more straightforward in this aspect due to their inherent simplicity.

Maturity Dates

convertible notes have a predefined maturity date, often ranging from 1 to 3 years. If the startup hasn't raised a subsequent funding round by this date, the convertible note becomes due, either requiring repayment with interest or converting into equity at a predetermined valuation. SAFE notes lack a maturity date, eliminating the pressure of repayment.

Structure

The structural differences between SAFE notes and convertible notes highlight the variance in legal complexities. SAFE notes are relatively concise and simpler, while convertible notes involve more detailed terms and conditions, contributing to their more standardized nature.

How RSUs Fit the Picture

While Restricted Stock Units (RSUs) aren't directly convertible securities, they wield considerable influence in the broader context of startup financing. In the context of convertible securities, RSUs play an indirect yet impactful role. They can affect perceptions of valuation, as potential employees gauge the value of their future compensation against the company's perceived worth. As you contemplate whether to opt for a SAFE Note or a convertible note, consider the influence RSUs can exert on prospective employees' decisions to join your startup.

Additionally, the presence of RSUs can signal the health of your startup to potential investors. These equity units showcase a commitment to a shared success story, where every team member holds a stake in the company's growth. This alignment of interests can resonate positively with investors, underscoring the dedication and passion driving your startup forward.

In other words, RSUs inject an element of equity into the funding equation, even if not directly as convertible securities. Their presence can shape perceptions, attract talent, and amplify the narrative of your startup's journey.

Bottomline

As a startup founder, it's necessary to evaluate your specific needs, investor preferences, and the stage of your business when considering whether to opt for a SAFE note or a convertible note. Each instrument has its strengths and considerations, ultimately contributing to the diverse financial landscape that fuels innovation and growth in the startup ecosystem. Whether you're drawn to the elegance of a SAFE note or the structured certainty of a convertible note, convertible securities remain a powerful tool in the arsenal of modern startup fundraising.

Curious about RSUs? Upstock has the most flexible RSU plans that can be tailored to fit your equity requirements and business bottom lines. Book a demo today and join dozens of startups and early-stage companies reaping their equity benefits.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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