If you spend any time around startups, you’ll probably hear people talk about raising money using “convertible notes” or “SAFEs.” These aren’t fancy finance buzzwords—they’re just pretty straightforward ways for young companies and investors to get on the same page when things are just getting started. Still, the details actually matter, and it’s easy to get lost in the jargon if you’re new.
Let’s walk through what these two agreements are, how they work, how they’re different, and why a founder or an investor might pick one over the other.
What is a Convertible Note?
A convertible note is basically a loan that turns into equity—ownership—in a company later on. Usually, a startup raises money using a convertible note when it’s too early to figure out what the company is worth. Instead of agreeing on a value, the investor loans money to the company, and that loan becomes shares later, once a full investment is raised and a valuation is set.
Let’s say you invest $50,000 on a convertible note. When the startup raises more money—like in a true seed or Series A round—your note “converts.” That $50,000 becomes shares in the company, and you become an owner. There are typically perks built in, like a discount on the new price per share, or a “valuation cap,” basically a ceiling on the price you’ll pay for your shares.
Convertible notes often have a maturity date, meaning the loan comes due if it doesn’t convert by a certain point. They can also accrue interest, just like any other loan. But most people in startups expect the note will convert and aren’t in it for the interest.
Why Use a Convertible Note?
The main plus here is speed—and less legal fuss. Convertible notes usually mean less paperwork and legal fees than a full investment round. If both sides are okay with holding off on valuing the company, the process moves quicker.
Investors like convertible notes because they get first dibs on new shares and often get a better deal than later investors (thanks to discounts or valuation caps). Startups appreciate getting needed cash without the stress of valuing a company that’s just getting off the ground.
Of course, there can be downsides. If the company never raises a follow-on round, investors may be left holding debt the startup can’t repay. There’s also a risk the note doesn’t convert, and legal complications can crop up if things don’t go as planned.
What is a SAFE (Simple Agreement for Future Equity)?
SAFEs showed up around 2013, and they’re pretty popular, especially for seed rounds. A SAFE isn’t a loan, doesn’t have interest, and doesn’t have a due date. Instead, it’s a contract: if the company raises a new round, the SAFE converts into shares—just like a convertible note.
The idea behind a SAFE is simplicity. SAFEs remove the messy parts of debt and keep the paperwork light. For investors, it’s a bet: If the company grows and raises more money, you’ll become an owner at a favorable price (again, often with discounts or valuation caps).
Unlike convertible notes, if the startup doesn’t raise another round, nothing needs to be paid back. Investors might get nothing, but they’re not creditors.
Why Use a SAFE?
SAFEs are simple, fast, and cheap to set up. Since there’s no interest or maturity date attached, they’re less stressful for founders worried about looming deadlines or repayments.
On the investor side, SAFEs can still give you favorable future equity terms. Y Combinator, Silicon Valley’s most famous accelerator, pretty much normalized and promoted SAFEs for early-stage investing. Now, they’re standard in early fundraising, especially for companies just starting to grow.
There are some issues to consider. SAFEs can be abstract—some investors worry they don’t offer enough protection if a company never raises a new round, or businesses simply walk away. Plus, if a startup issues too many SAFEs, ownership can get muddled, and there can be confusion at the next big fundraise about who owns what.
SAFEs don’t work exactly like stock or debt, so both sides need to be clear on the terms.
How are Convertible Notes and SAFEs Different?
Both instruments aim to keep fundraising simple for early startups, but the details can add up. Let’s run through a few practical differences:
– Convertible notes are loans. They typically accrue interest and have maturity dates. SAFEs are contracts without interest, and they don’t have to be paid back.
– If a convertible note reaches its maturity date and hasn’t converted, investors can technically demand their money back, though in reality, most don’t. SAFEs can sit indefinitely until another investment round or liquidity event (like a sale).
– Both usually include discounts and valuation caps, letting early investors buy future shares at a better price than new money. But the legal language and math can differ. If you’re dealing with a tight fundraising timeline, some folks prefer the clear deadlines of convertible notes. If you value simplicity—and are cool without a maturity date—SAFEs might feel smoother.
– On dilution: Both can convert into equity, so they both dilute existing ownership. However, the formula for calculating how much ownership they get can be clearer (or at least more predictable) with a SAFE—there are fewer variables.
– Taxes can be simpler with SAFEs, since they’re not debt instruments like notes.
When Do Convertible Notes Make More Sense?
Some founders or investors still pick convertible notes over SAFEs. For instance, maybe the investor feels uncomfortable giving money without a maturity date or a plan for payback if things stall out.
Also, if a company is already raising from more traditional investors—like a seed fund or VC firm—they may prefer the structure of a note. Sometimes, a company has existing loans or other debts, and lining up more convertible notes just works.
There are stories of startups raising with convertible notes and never needing to repay the loan part—because the note converted cleanly at the next big fundraising. You’ll hear examples from SaaS founders who wanted a more “formal,” contract-bound investment, or cases where an investor wanted the extra fallback option, just in case.
If you’re looking for clear deadlines and a safety net for your investment, or if you know your company won’t raise for a while, convertible notes may line up with your goals.
Times When SAFEs Work Better
Let’s say you’re a founder trying to avoid piling up debt or worrying about technical maturity dates. You really just want simple, fast paperwork. You’ve got friends and early supporters willing to invest but not haggle over loan terms. In cases like this, a SAFE could save a ton of headaches.
SAFEs are the go-to for accelerator-backed businesses, or for founders who need dozens of smaller checks without endless negotiations. Many consumer startups, direct-to-consumer brands, and small SaaS companies have closed their first rounds using nothing but SAFEs.
One example: a health-tech startup raised $500,000 using SAFEs from lots of individual angel investors. When they raised their first big round, all the SAFEs automatically converted—no haggling, no back-and-forth, just shares issued. The founder loved not worrying about interest rates or looming due dates.
Legal and Financial Things to Keep in Mind
Whichever route you pick, don’t gloss over the legal fine print. Convertible notes are still loans, and improper handling can land both sides in regulatory trouble. SAFEs are a bit newer, so some investors and lawyers might hesitate or push for edits to the standard forms.
There are also tax issues to keep in mind. Convertible notes might impact your company’s tax filings, especially since the interest accrues even if it never gets paid out. SAFEs, not being debt, usually avoid interest tax complications—but can introduce other questions about timing and fair value.
And finally, these days there are lots of standardized forms (Y Combinator’s SAFE, or Techstars’ note), but you should still have a lawyer check your paperwork. Compliance, especially with SEC rules, can come into play if your investors aren’t friends or family or if you raise larger sums.
If you want more background on how convertible instruments fit into startup fundraising, this article has a helpful walkthrough.
Wrapping it All Up: Which One Should You Pick?
It would be nice if there was one obvious answer, but honestly, the right choice depends on your situation. If you know your company is moving fast and will raise more cash soon, maybe a SAFE keeps things cleaner. If your investors expect a backup plan or come from finance backgrounds, they might only be comfortable with notes.
For each, the big appeal is speed and simplicity. Understand your goals, talk with your investors, and use a lawyer to spot any deal-killer terms before you sign.
Frequently Asked Questions (FAQs)
Do convertible notes always convert into equity?
Usually, yes. But if the startup never raises a qualifying round or hits its maturity date, the investor could in theory ask for repayment.
Do SAFEs ever turn into debt?
No, SAFEs don’t become loans. If a follow-on round never happens, the SAFE just stays on the books, and the investor won’t become a creditor.
Are SAFEs riskier than notes?
It depends. With a SAFE, investors don’t get paid back if things don’t work out, but they also don’t have to worry about managing loan terms or interest.
Can I use both in one round?
It’s technically possible, but mixing instruments often creates confusion. Most experienced founders stick with one type per round to keep things easy to manage.
Does my company need a lawyer to use these?
Absolutely. Even the simple forms can have big impacts, and the details can make a big difference down the line.
That’s the core of it: both instruments offer founders and investors a way to get started without a lot of fuss. The best move is to weigh your options, think through what feels right for your team, and get expert help to tie up the legal details. In the startup world, it pays to keep things straightforward—and to know what’s in your paperwork before you sign.