SAFE vs. Convertible Note: What Founders Actually Sign

Every early-stage founder eventually has the same conversation: an investor is ready to wire money, but nobody can agree what the company is worth yet. Pricing a company with no revenue history is guesswork, and a priced round takes lawyers and weeks. So the industry built two shortcuts that let the money move first and the price get set later: the convertible note and the SAFE.

They look similar from a distance. Close up, one is a loan and the other isn’t, and that difference matters most when things don’t go to plan.

Two ways to take money before you know the price

A convertible note is debt. In his Haynes Boone primer on SAFEs and convertible notes (October 13, 2021), attorney Roger Royse writes that notes accrue interest and carry a maturity date, typically a “relatively short term (1 to 2 years).” Amplify Partners, in its own explainer (August 2023), puts maturity at “often around 18 months” and adds that notes usually let investors extend it. If a qualifying financing closes first, the note converts into stock. If it doesn’t, the note comes due.

A SAFE, a Simple Agreement for Future Equity, is a different animal. Y Combinator, where Carolynn Levy created it in 2013, describes it as “a short contract an investor signs to fund your startup now,” and says it is “not stock until it converts into preferred stock,” which happens when the company raises a priced round. YC’s FAQ is blunt about the part that matters to founders: a SAFE “is not a debt and not a loan — it has no interest and no maturity date.”

The deadline is the point

Everything else is detail next to that last difference. A note has a clock on it. Royse spells out the consequence: if the company doesn’t close a qualified financing before maturity, the note becomes payable and, if unpaid, is in default. A founder who raised on a note and is six months short of a Series A is no longer negotiating a round, but negotiating with a creditor, who may extend, convert on new terms, or demand repayment.

A SAFE can’t do that, which Royse says makes it more attractive to issuers. The trade is that SAFE investors take on more risk, since they have no repayment claim and no interest. Both instruments, he notes, typically become payable in full if the company dissolves or enters insolvency, and both are securities, so selling either generally means complying with securities rules such as Regulation D.

The two levers: cap and discount

Early investors are taking a bigger risk than the people who invest at the priced round, so both instruments commonly reward them with a better conversion price. There are two standard ways to do it.

The valuation cap is, in YC’s definition, “the highest valuation at which a SAFE converts into shares.” Royse’s example: with a $10 million cap and a company later valued at $20 million, the instrument converts as though the company were worth $10 million. Amplify gives the same example for a SAFE with a $10 million post-money cap, noting that the investor ends up with more ownership.

The discount gives early investors “a lower price than your startup’s next priced round,” in YC’s words. Royse says discounts usually run 10% to 30%, often 20%, meaning every $80 invested buys $100 of stock in the priced round. Amplify’s worked example: a $1,000,000 note with a 20% discount against a $1.00 share price converts at $0.80, yielding 1,250,000 shares instead of 1,000,000.

Royse writes that almost all convertible instruments today include a valuation cap. YC’s third variant, the MFN SAFE, has neither: it “automatically takes the valuation cap or discount of any SAFE you issue later.”

Post-money vs. pre-money: who absorbs the dilution

The cap sounds simple until a company issues several SAFEs. The question is whether the cap is measured before or after the SAFE money comes in.

YC defines a post-money SAFE as one whose cap is “the valuation of your company after the investment is made,” and says it has been “the YC standard since 2018.” The founder-friendly consequence is arithmetic: YC states that “the ownership you sell equals the investment amount divided by the valuation cap.” So $1 million on a $10 million post-money cap sells 10%, and the investor knows that number at signing.

In a pre-money SAFE, Royse explains, founder and investor share the dilution from later SAFEs, which generally favors the company. Under the post-money version only the founder is diluted by later SAFEs, which he says favors investors. Neither is wrong, but a founder stacking several post-money SAFEs should model the combined percentage before signing the fourth.

What to check before you sign

• Is there a maturity date? If the instrument is a note, know the date, the extension terms, and what “qualified financing” means, because that definition decides whether you convert or owe.
• Is the cap pre- or post-money? It changes who absorbs the dilution from every instrument you sign afterward.
• Can you compute the percentage? Divide the investment by the post-money cap. If you can’t reproduce the investor’s number, ask.
• Are there side terms? YC says pro rata rights, the investor’s right to buy into later rounds, are optional and “live in an optional, standardized side letter rather than in the SAFE itself.” Make sure you know whether one is attached.
• Read the liquidation terms. Royse warns that older instruments could convert into the same preferred stock as new investors, with liquidation preferences above the discounted price, so $0.80 of conversion price could carry a $1 preference. Modern instruments often use shadow series to avoid this windfall.

Neither instrument is a better deal in the abstract. A SAFE is lighter and removes the repayment clock; a note gives an investor a creditor’s claim in exchange. The point is to know which of those you signed.

Related reading

• How the 83(b) Election Actually Works: the 30-day tax deadline that applies once founder equity is issued.
• How Startup Vesting Actually Works: what happens to equity after the money is in.
• How to Split Equity Between Co-Founders: the ownership question that comes before any SAFE is signed.

The definition of a SAFE, its creation by Carolynn Levy at Y Combinator in 2013, the post-money form becoming YC’s standard in 2018, the valuation cap, discount and MFN definitions, the “ownership sold equals investment divided by cap” formula, the pro rata side letter, and the statement that a SAFE has no interest and no maturity date are per Y Combinator’s own documents page (opened directly). Convertible-note interest and maturity (1 to 2 years), the default risk at maturity, typical 10% to 30% discounts, the $10 million cap example, pre- vs. post-money dilution, tax treatment, securities-law notes and the liquidation-preference warning are per Roger Royse’s Haynes Boone article of October 13, 2021 (opened directly). The roughly 18-month note maturity, investor extension rights, and the $1,000,000 / 20% discount example are per Amplify Partners’ August 2023 explainer (opened directly). These are general educational descriptions, not legal or tax advice; terms vary by document.