Convertible Notes vs SAFEs: What Founders Should Know

When early-stage startups look to raise capital, two financing instruments often come to the forefront: Convertible Notes and SAFEs (Simple Agreements for Future Equity). Both offer a way to raise funds without setting a valuation too early, which can be ideal for companies still proving their business plan. But while they serve similar purposes, they differ significantly in structure, risk, and implications for both founders and investors.

As a founder, understanding these differences is critical—not just for compliance with securities laws, but for protecting your company’s future cap table and avoiding unintended dilution.

The Basics: What Are They?

Convertible Notes

A convertible note is a type of short-term debt that converts into equity, typically at a future equity financing round. The idea is that the investor loans money to the company, and instead of receiving repayment in cash, the investor gets equity, or the option of getting equity—usually at a discount or with a valuation cap when the next priced round occurs.

Because it’s a debt instrument, a convertible note will include an interest rate and a maturity date. If the note hasn’t converted by the maturity date, the investor may be entitled to repayment—or renegotiation.

SAFEs

A SAFE is not a loan. It’s an agreement that gives investors the right to receive equity at a future financing event. SAFEs are designed to simplify early-stage financing by eliminating the debt features of convertible notes. There’s no interest rate, no maturity date, and generally fewer legal complexities.

SAFEs can include features like a valuation cap, a discount, or both. Some SAFEs also convert in liquidity events (e.g., acquisition or IPO) if a priced round never occurs.

Key Differences Founders Should Understand

1. Debt vs. Equity Instrument

This is the most fundamental distinction. A convertible note is a debt instrument. That means it creates repayment obligations and can pose legal risks if it matures without converting. Founders must be prepared for the possibility that the investor could demand repayment or renegotiate terms—neither of which is ideal during a startup’s fragile early years.

SAFEs, on the other hand, are not debt. There’s no maturity date and no obligation to repay. This gives founders more breathing room. However, SAFEs aren’t without risk. Because they sit on the cap table as a convertible right, they can still lead to significant dilution when they convert—especially if poorly understood or poorly structured.

2. Legal and Compliance Considerations

While both instruments are typically offered under exemptions from registration (most commonly Regulation D Rule 506(b) or 506(c)), convertible notes may trigger state usury laws or raise issues under lender licensing statutes, particularly if the interest rate is high or the note is offered across multiple jurisdictions. Additionally, because they are debt instruments, convertible notes may require more extensive disclosure and negotiation with investors.

SAFEs, due to their simplicity, tend to be easier and less expensive to issue. But they’re still securities under U.S. federal law. That means they must be offered only to accredited investors (unless another exemption applies), and appropriate Form D filings must be made. Ignoring securities compliance, even for SAFEs, can lead to enforcement risk and investor claims later on.

3. Impact on Future Fundraising

Both SAFEs and convertible notes are designed to convert into equity at a future round, but the mechanics can affect your capitalization table in ways that surprise first-time founders.

For example, stacking multiple rounds of SAFEs or notes with different valuation caps can create a complex and dilutive conversion at the next priced round. If you raise $1M in SAFEs with a $5M cap, and $1M more with a $10M cap, those early investors will convert at different prices—and you may give away far more equity than anticipated.

Convertible notes with accrued interest can exacerbate this problem, since the interest also converts to equity, increasing dilution.

Pro tip: Always model out how SAFEs or notes will convert under different funding scenarios before signing anything.

4. Investor Expectations

Some investors prefer convertible notes because they look and feel like a loan—and can include default protections if the startup fails. Others prefer SAFEs for their simplicity and founder-friendliness.

Founders should also understand that not all SAFEs are created equal. Some offer more founder-friendly mechanics, like “post-money” valuation caps (as opposed to pre-money), which provide greater clarity about dilution. However, they can also lead to more dilution for the founders if not modeled carefully.

5. Conversion Triggers and Liquidity Events

Both instruments typically convert at the next equity financing round, but they can behave differently in a liquidity event. A convertible note might require repayment or convert into equity based on a change-of-control clause. A SAFE usually includes language to convert into common or preferred stock, or pay out based on investor protections.

Founders should discuss these provisions with their counsel and be certain to understand how they work—especially if acquisition or early exit is on the horizon.

So, Which Should You Use?

There’s no one-size-fits-all answer. But here are a few practical takeaways:

• Use SAFEs if: You want simplicity, low legal costs, and you're raising from friendly or repeat investors who don’t demand debt protections.

• Use Convertible Notes if: Your investors expect interest or repayment rights, or you're raising in a jurisdiction where SAFE treatment is uncertain.

• Avoid both if: You're at the stage where a priced equity round is feasible—this provides the most transparency and cleanest cap table long term.

Final Thoughts

Convertible notes and SAFEs are powerful tools for startup fundraising, but they carry real consequences for ownership, control, and compliance. Founders should resist the temptation to “set it and forget it.” These instruments may look simple on paper, but the math can get complicated quickly—and the legal implications even more so.

BEFORE raising on either instrument, consult with counsel experienced in securities law and startup finance. It’s an investment that could save you significant headaches—and equity—down the line. Contact me today for a consult.