Understanding Venture Capital: What's the difference between a SAFE and a Convertible Note?4/11/2024 by Colaeb
A SAFE (Simple Agreement for Future Equity) and a convertible note are both financial instruments commonly used in early-stage startup financing. While they serve similar purposes, there are some key differences between the two. Let's discuss them: 1. Nature: A SAFE is an agreement to purchase equity in a future financing round, whereas a convertible note is a debt instrument that can be converted into equity. 2. Debt vs. Equity: A convertible note is a form of debt that carries an interest rate and a maturity date. It represents a loan from an investor to the startup, which can be converted into equity at a later financing round, typically at a discount to the price paid by the new investors. On the other hand, a SAFE does not have a maturity date or an interest rate. It represents the right to receive equity in the future, but it does not have an explicit repayment feature. 3. Conversion: The conversion mechanism differs between the two instruments. In the case of a convertible note, it typically converts into equity when a qualified financing round occurs, typically triggered by the entry of a lead investor or the achievement of a specific funding threshold. The conversion price is usually determined based on a discount or a valuation cap. In contrast, a SAFE converts into equity upon the occurrence of a specific triggering event, such as a subsequent financing round, acquisition, or IPO. The conversion price is usually determined in the subsequent financing round, without a discount or valuation cap. 4. Interest and Repayment: As mentioned earlier, a convertible note carries an interest rate, which accrues over time until conversion or repayment. Upon maturity, if the note has not been converted, it becomes due and payable by the startup. A SAFE does not carry an interest rate, nor does it have a repayment obligation. 5. Documentation: Convertible notes are typically more detailed and have a longer legal document associated with them, outlining the terms and conditions of the loan, conversion mechanics, interest rate, maturity date, and other provisions. SAFEs, in contrast, are generally simpler and shorter agreements, with fewer terms and conditions. 6. Investor Protection: Convertible notes provide more investor protections compared to SAFEs. They often include provisions like a maturity date, an interest rate, and repayment terms, which can provide some security to the investor in case of adverse events, such as the startup's failure to raise subsequent funding. It's important to note that the specific terms and conditions of both SAFEs and convertible notes can vary depending on the negotiation between the startup and the investor. It's advisable to seek legal and financial advice when considering these financing instruments, as their suitability depends on the specific circumstances and goals of both the startup and the investor.
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