It used to be that the easiest way to raise investment capital for your startup was to issue convertible notes. It was simple because you didn't have to negotiate all of your investor rights, didn't have to set the valuation for your shares, etc. You just had to negotiate a few terms related to interest, maturity dates, and conversion terms, and you were able to quickly close your financing. And then, when you end up raising money in a "qualified financing" (e.g., your Series A round), the convertible note would convert into preferred stock on the same terms as the cash investors in that financing (though they would typically convert at a lower price per share to reflect that they took on more risk and invested earlier in the company). Compared to a preferred stock financing, it was a lot simpler and had a lot lower legal fees to get the financing closed.
However, in 2013 the folks at YCombinator realized that disproportionately large amount of negotiations in convertible note financings, and the resulting legal fees, could be attributed to certain terms that in the long run had little impact on the overall investment terms. So they came up with the Simple Agreement for Future Equity (commonly called the SAFE for short). You can view YCombinator's information about the SAFE on their website here. With the SAFE, they simplified early-stage investments by removing negotiations about interest and maturity date, and standardized the investment document to avoid negotiations between law firms who preferred slightly different forms for their convertible note investments.
SAFEs v Convertible Notes
So, what is the difference between a SAFE and a Convertible Note?
A SAFE differs from a Convertible Note primarily by removing the standard "debt" features that are built in to convertible notes: interest and maturity date. You can still have a SAFE that converts into common stock prior to an acquisition event, you can still do valuation cap conversion or conversion discounts. However, it won't be treated as a liability on the balance sheet, and will not accrue interest or have a forced maturity repayment. Because of this, it is seen as more "founder-friendly," but it is also much more streamlined for both the investor and the founder, with fewer terms to negotiate and considerably lower transaction costs.
Choosing an Convertible Type
Most founders these days will prefer a SAFE over a Convertible Note. There are two types of SAFE to consider, and you can understand the differences between them here. A SAFE will typically be quicker and easier to draft and negotiate, and will avoid the pain that comes with interest and maturity dates.
Some investors still prefer to use convertible notes, and that is fine, as long as the founder understand that the investor's "investment amount" (the amount that will ultimately convert into equity in an equity financing) is constantly increasing because of interest, and that as soon as the maturity date hits, technically that investor has the right to hold your company hostage to pay off their investment if you haven't yet converted.
If you'd like to do a convertible financing, you can generate relevant term sheets, board consents and investment instruments directly on Savvi using the following links:
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