A Practical Guide to SAFEs and Convertible Notes for Startups

Anne Veerpalu
Aug 4
2 min read

🔹 What Are They?

Convertible Notes and SAFEs (Simple Agreements for Future Equity) are alternative financing instruments that let startups raise capital early without setting a definitive company valuation. These methods are particularly useful for founders who want to delay pricing their equity until a larger funding round.

🔹 Convertible Notes — At a Glance

Convertible notes are short-term debt instruments that investors can convert into equity in the future, typically when a new funding round occurs.

Key Components:

Interest Rate: Typically 4–10% annually.
Maturity Date: Generally 2–5 years.
Conversion Trigger: Usually a future equity round or acquisition.
Discount Rate: Investors may convert at a reduced price (commonly 20% off).
Valuation Cap: Sets an upper bound for conversion price to protect early investors.
MFN Clause: Adjusts terms if future notes offer more favorable conditions.

Example: If an investor puts in €500,000 with a 5% interest over two years, they may convert that €550,000 (principal + interest) into shares at a pre-agreed discounted rate or valuation cap.

🔹 SAFEs — A Flexible Alternative

SAFEs are not loans. They are agreements to issue equity at a future time, usually the next priced funding round.

Why Founders Like Them:

No interest or maturity date
Simple and fast to implement
Avoids immediate equity dilution
Common in pre-seed or seed stages

Key Terms:

Discount Rate: Reduces the price per share when converting to equity.
Valuation Cap: Protects early investors if the company’s value grows quickly.
Pro Rata Rights: Option to maintain ownership in future rounds.
MFN Clause: Adapts terms to match better future deals.

SAFE Types:

With cap / no discount
With both cap and discount
With discount / no cap
MFN-only (no cap or discount)

Example: €100,000 invested with a €5M cap converts into 20,000 shares if the next round prices the company at €10M (i.e., €5/share via cap vs €10/share).

🔹 SAFEs vs. Convertible Notes vs. Equity Rounds

Criteria	SAFEs	Convertible Notes	Equity Rounds
Type	Contract for equity	Loan convertible to equity	Direct equity issuance
Valuation Needed?	No	No	Yes
Repayment Required?	No	Yes, unless converted	N/A
Accrues Interest?	No	Yes	N/A
Legal Complexity	Low	Medium	High
Investor Risk	Medium	Medium–High	Lower (priced in)

🔹 Potential Pitfalls to Watch Out For

For SAFEs and Notes:

Automatic conversion at low valuations
Mandatory redemption clauses

For Convertible Notes:

High interest burdens
Early repayment penalties

Startups should avoid unfavorable clauses that lead to unexpected dilution or cash flow issues.

🔹 Summary

SAFEs and convertible notes are excellent tools for raising early-stage capital efficiently. However, they require careful handling to avoid cap table confusion, valuation mismatches, or investor dissatisfaction.

Founders should: