SAFE vs convertible note

What it means

A convertible note is a loan. It carries an interest rate and a maturity date, and if no priced round happens before maturity the money is in principle repayable, though in practice it is usually extended or converted by agreement. A SAFE, standing for simple agreement for future equity, is not a loan. It has no interest, no maturity and no repayment right, so it either converts into shares or it does nothing. Both normally carry a valuation cap, a discount, or both, which is how the early investor is compensated for taking the earlier risk.

Why it matters

The difference only shows up when things go badly, which is exactly when it matters. A note that reaches maturity without a priced round puts a repayable debt on the balance sheet of a company that by definition has not raised, which gives the holder leverage at the worst possible moment. A SAFE cannot do that. Against this, notes are better understood by lawyers and registrars outside the US, and in several European jurisdictions the local convertible loan is simply the instrument that the legal system expects.

Worked example

Two founders each raise EUR 500,000 on a EUR 5m cap, one on a SAFE and one on a note at eight percent interest with a two year maturity. Eighteen months later both raise a priced round at EUR 10m pre-money. The SAFE converts on EUR 500,000 at the cap. The note converts on EUR 500,000 plus around EUR 61,000 of accrued interest, so the note holder receives roughly twelve percent more shares for the same cash. Had neither company raised, the SAFE holder would have waited and the note holder could have demanded EUR 561,000 the company did not have. Run the note two years further and the gap widens: at eight percent compounding, EUR 500,000 becomes roughly EUR 585,000 by the end of year two, so a note that sits unconverted through a slow period quietly buys its holder a larger share of the company than the headline suggested.

The common mistake

Comparing the cap and treating the rest as boilerplate. Interest is not boilerplate: at eight percent over two years it is a sixteen percent increase in the amount converting, which is a larger effect than most discount negotiations. The other mistake is a founder outside the US reaching for a SAFE because it is the well known name, without checking whether their jurisdiction has a form that works better. In Germany that form is the Wandeldarlehen; in the UK it is the advance subscription agreement.

In practice

In the US the post-money SAFE is the default. In Germany the Wandeldarlehen dominates, and it is a note rather than a SAFE, so it carries interest. In the UK the ASA is the norm because of SEIS and EIS eligibility. Pick by jurisdiction rather than by familiarity, and if you are offered a note, model the interest as part of the price rather than as an afterthought. Whichever you sign, keep the conversion terms somewhere you will find them in two years.

What to ask

Ask which instrument it is and, if it is a note, what the interest rate and maturity are, then work out the amount that will actually convert rather than the amount being lent. Ask what happens at maturity if no priced round has closed, and press for a specific answer, because automatic conversion at a stated valuation is far better for both sides than a repayment right nobody can honour. Ask whether the instrument is the right one for your jurisdiction rather than the one the investor last used somewhere else, since the answer in Germany is usually a Wandeldarlehen and in the UK an advance subscription agreement, and using the familiar American form instead can cost the investor tax relief they were counting on. Ask what happens if the company raises a small bridge instead of a full round, since many instruments only convert on a qualified financing above a threshold and a bridge can leave them outstanding.

Related terms

• Advance subscription agreement (UK) The UK instrument for money paid now against shares issued later, built to stay eligible for SEIS and EIS relief.
• Pre-money vs post-money SAFE Which of the two SAFE forms you signed decides whether your other convertibles dilute the investor or dilute you.
• Fully diluted shares The share count that assumes every option and every convertible has already converted. The only number worth quoting.