A convertible note is a debt, while a SAFE is non-debt convertible security. A convertible bond thus requires an interest rate and maturity date, while a SAFE does not.
A SAFE is better and easier than most convertible notes, and shorter. In a future priced equity round, both SAFEs and convertible notes convert into equity; a convertible note may be more complex to when / if / how it converts. Both SAFEs and convertible notes are capable of valuation, discounts, and most-favored nations.
As a startup manager, you have at your fingertips a range of possible funding investments while investing and engaging with partners. Some of these are the convertible notes and SAFE notes. They have a ton in common but do have their own benefits and drawbacks.
What is a Convertible Note?
A convertible note is a type of debt entitled to convert to equity when you hit a milestone agreed upon. Convertible notes are somewhat close to SAFE notes which vary by the fact that they are:
Include a time limit, also known as the maturity date, where the debt must be converted into equity or repaid irrespective of the company’s current value.
They are much longer than a SAFE note, so one or both parties are more likely to misunderstand them. FundersClub describes convertible notes as an investment instrument and is strictly designed for a bond. Nevertheless, as TechCrunch points out, when a Series A investment round has completed this form of debt immediately turns into shares of common stock. The general view on convertible notes is that they are considered to be complicated, and thus, finicky or glitchy.
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What is a SAFE note?
SAFE is an acronym that stands for “simple agreement for future equity” and was created as a new financial instrument to simplify seed investment by Silicon Valley accelerator Y Combinator. This is a contract between an investor and a company owner, typically a founder or co-founder of a startup. In an investment process this arrangement is signed, sometimes in the pre-sale or sale phases.
A SAFE notice covers all lender and entrepreneur’s interests, with well-delineated guidelines for how to handle investments as a new investment round is reached. Typically that’s Series A financing. A SAFE is at its core a warrant to buy stock in a priced round to come.
Safe Vs. Convertible:
SAFE Offers Simplicity:
As stated in the description, convertible notes may be lengthy and complicated. On the flip side, a SAFE is a 5-page paper produced to streamline the cycle of seed investment. Because simplicity is one of its prime aims, SAFE provides a simple option: SAFE has no interest rate and no maturity date.
Specific stages of asset conversion:
Both Safe notes or convertible notes will allow conversion into equity. The distinction here is that while a convertible note may permit the conversion into the current stock round or a future financing case, a SAFE only requires conversion into the next financing round. Usually, convertible notes often function when a ‘qualifying expenditure’ happens (more than the minimum sum specified by the agreement) or whether all parties consent on the transfer. The SAFE can convert if you raise any amount of investment inequities.
Low-interest rates vs. Zero:
SAFEs are not a debt-tool. They’re known as a warrant, instead. That means they do not carry a rate of interest. Nevertheless, convertible debt may bear a rate of interest varying from 2%-8% (most dropping about 5%).
Since most entrepreneurs need no further expense, the clear winner in this category is SAFE. It is also another example of how convenience SAFE provides.
The pros of SAFE notes:
- Less difficulty, which means they don’t need any time to handle. Technically, that often ensures that no lawyer is needed to read a SAFE notice. However, there really should always be the use of legal representation.
- No interest rate payments, so founders can receive the same investment amount as they would with a convertible note, but with a lower payment.
- There are fewer stipulations attached, to keep the agreement clear, concise, and easy to understand.
The Pros of Convertible Notes:
These could have simple exchange stipulations added to the maturity date, such as transferring loans to stock or reimbursing the principal debt and interest. While the maturation deadline itself traps the creator into a migration timeline, they have further flexibility for how to handle the change.
Convertible notes provide enhanced leverage. More stipulations should be applied to ensure the designer gets the precise deal they want, rather than the simple, simplified package that a SAFE notice provides.
We’ve broken down the similarities and differences between SAFE and convertible notes, but at the end of the day what could be a pro for one startup might be a con, especially at this stage in your crowdfunding journey.
