Convertible note or SAFE: the differences founders find out about late

One of them is a loan and one of them is not

A convertible note is borrowing. The company signs a promissory instrument, the money arrives as debt, interest accrues, and there is a date by which it has to be dealt with. The conversion feature is what makes it a venture instrument rather than a bank loan: instead of cash repayment, the balance turns into shares at the next priced financing, on terms fixed now.

A SAFE — a simple agreement for future equity — strips the debt out. It is a contractual right to shares on a future event. There is no maturity date, no interest, and nothing that can be demanded back. If the triggering event never happens, the SAFE simply stays outstanding.

That difference sounds procedural and is not. Debt changes what a company can survive, and it hands the holder a lever nothing in a SAFE provides.

What the maturity date actually does

Maturity on an early-stage note is commonly eighteen to twenty-four months out. If no priced round has happened by then, principal and accrued interest become repayable. A pre-revenue company almost never has the cash, which is exactly why the date matters.

A SAFE has no equivalent. Nothing falls due on any date, so the investor has no procedural moment at which to reopen terms. That is the strongest practical argument for a SAFE from the founder side, and the main objection to it from an investor who wants a deadline in the document.

The cap and the discount are two different promises

Both instruments carry the same two economic terms, and founders routinely treat them as one.

• The valuation cap sets a ceiling on the valuation used to convert. If the cap is $8m and the round prices at $20m, the early money converts as though the company were worth $8m — roughly two and a half times the shares the new investors get for the same cash.
• The discount is a percentage off the price per share the new investors pay, commonly 10 to 20 per cent. It never depends on the company being worth more than a stated figure; it simply rewards being early.

Where an instrument carries both, they are alternatives rather than additions. The holder converts on whichever calculation produces more shares — the cap in a round priced above it, the discount in a round priced below. A term sheet that appears to stack them is worth reading again.

Pre-money, post-money, and where the dilution went

The original SAFE used a pre-money cap: the cap described the company before the SAFE money went in, so the investor's eventual percentage could not be worked out until conversion, and every later instrument diluted the earlier holders as well as the founders. Y Combinator replaced it in 2018 with a post-money version, which is now the standard form.

A post-money cap includes the SAFE money itself and every other convertible converting alongside it. That makes the arithmetic trivial — ownership equals the investment divided by the cap, so $500,000 on a $6.7m post-money cap is about 7.5 per cent — and it fixes that percentage on the day of signature.

This is the change most founders have not internalised. Under the old form, a second SAFE spread the cost across everyone already holding one. Under the post-money form each holder keeps exactly the percentage promised, and everything raised afterwards on a convertible comes out of the founders and the option pool.

What conversion actually looks like

Conversion is not one event with one definition. Read which triggers your instrument names: SAFE forms and note forms differ, and the gap decides what happens if the company is acquired before it ever prices a round.

1. An equity financing — the standard trigger. The instrument converts into the shares issued in that round, or into a shadow series with the same economics at a price set by the cap or the discount.
2. A liquidity event — an acquisition or a listing. The holder typically chooses between taking their money back and converting into common stock, which is what matters when a company sells early and cheaply.
3. Dissolution. The holder ranks ahead of common shareholders for whatever is left, which is usually nothing.
4. Maturity, on a note only. No conversion right at all, just a debt that has come due.

Conversion also has to be papered. The shares are issued by the company, so the board approves them by written consent or resolution, and the new holders join the shareholder agreement alongside the priced-round investors. Missing paperwork here is one of the standard diligence findings covered in what belongs in a shareholder agreement.

MFN: the clause that rewrites itself

A most-favoured-nation provision says that if the company later issues a convertible on better terms, this holder may take those terms instead. Y Combinator publishes a SAFE that carries MFN alone, with no cap and no discount, which is a way of investing without arguing about price at all.

The consequence is that an MFN instrument has no fixed economics until you stop issuing convertibles. Give a later investor a $5m cap to close a round, and every MFN holder moves to $5m too. Founders sign it because it looks like a clause with no number in it. The number arrives later, set by whoever negotiates hardest after them.

Stacking, and why the cap table is a surprise

Instruments are raised one at a time, months apart, each at whatever cap the market bore that quarter. Nobody models them together, because each one on its own looks small.

Add a Series A taking 20 per cent and an option pool topped up out of the pre-money, and the founding team is under half the company having sold nothing they thought of as a round. Nothing here is a trick. Every instrument did what it said; they were never added up.

So which one

For a small early cheque the SAFE is simpler, cheaper and carries no date that can be used against you, which is why it has taken over the pre-seed market. A note is the better answer where the investor wants real downside protection, where the money bridges a round already in motion, or where local tax and company law have no settled treatment of a SAFE but do have one for a loan.

The instrument matters far less than the two numbers on it and the number of times you sign one. A founder with a single clean SAFE at a sensible cap has no problem. A founder with four instruments at four caps, one carrying MFN and two maturing next spring, has a problem no choice between the forms would have prevented — and one an afternoon with a spreadsheet, before the third signature, would have.