Table of Contents
This article introduces Convertible notes and SAFE notes and explains the differences between them.
Founders have two primary options for receiving seed investments into their Startups: Convertible Notes and SAFE notes.
Convertible Note
A Convertible Note is a type of debt instrument that has the right to convert into equity when certain milestones are hit.
This type of debt automatically converts into shares of preferred stock upon the closing of equity financing (when a startup sells shares of stock at a fixed price) Series A round of financing for example.
Convertible Notes typically include complex terms and triggers so it is prudent to hire a San Francisco or Silicon Valley attorney to help you understand the terms of Convertible Notes.
Convertible Notes terms
Convertible Notes typically trigger and convert when a “qualifying transaction takes place” (in accordance with the terms of the note purchasing agreement) or when both parties agree on the conversion.
As a legal requirement Convertible Notes include a maturity date, or the date the loan must be repaid, or extended if it has not been converted. If the next round of financing does not occur before the maturity date of a Convertible Note, the startup will have to either pay back the principal and interest of the loan in full, convert the debt into equity, or request an extension on the maturity date.
SAFE Note
Alternatively, founders may issue SAFE “Simple Agreement for Future Equity.”
A well-known Silicon Valley technology accelerator YCombinator created SAFE, so Silicon Valley investors are likely to be comfortable with them. SAFEs were created to simplify seed investments. In essence, a SAFE is a futures agreement to purchase stock in a future priced round.
Unlike convertible notes, SAFEs do not carry an interest rate and have no maturity date. SAFE convert into the next round of preferred stock that the company issues in the subsequent priced financing round.
SAFES convert when a priced round produces any amount of equity financing.
SAFE Note VS. Convertible Notes
Both SAFE and Convertible Notes allow for conversion into equity. The key difference is that while a Convertible Note can allow for the conversion into the current round of stock or a future financing event, a SAFE only allows for a conversion in the next round of financing or during a Merger or Acquisition.
A SAFE can convert when you raise any amount of equity investment. However, raising common stock does not trigger a conversion for a SAFE investor.
Convertible Notes and SAFEs offer similar payout mechanisms in the event of a change in control before a conversion can occur.
Both Convertible Notes and SAFEs include complex terms and triggers that can be perplexing for founders.
This can lead to existential problems for a startup like the dilution of shares.
The experienced attorneys at Sutter Law will help you understand the terms of SAFEs and Convertible Notes and avoid future problems. If you would like a consultation with an experienced business attorney please contact us.
