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What is a SAFE, and how is it different from a convertible note?

FundraisingEquity

A SAFE, a Simple Agreement for Future Equity, is a short contract under which an investor pays the company now and receives shares later, when the company sells preferred stock in a priced round. A convertible note does the same thing in the form of a loan: the investor lends the money, the loan earns interest, and instead of being repaid it converts into shares at that same priced round. Both exist because early companies are hard to value, and both leave the valuation to the investors who lead the next round.

What a SAFE has

A valuation cap, a discount, or both. The cap fixes the highest company value at which the investor's money converts, so an investor who came in at a $5 million cap converts as though the company were worth $5 million even if the round prices it at $20 million. The discount converts their money at a percentage below the round price. The standard form used across the industry today is the post-money SAFE, under which the investor's ownership after conversion is fixed by the cap and does not shrink as more SAFEs are sold. Founders should model that, because a stack of post-money SAFEs dilutes the founders, not each other.

What a note adds

Interest, usually modest, that also converts into shares. A maturity date, typically eighteen months to two years out, at which the investor can in principle demand repayment if no round has happened. In practice notes get extended rather than called, but the date gives the investor a lever a SAFE holder does not have. A note is debt on the balance sheet until it converts, and it should be approved by the board like any other borrowing.

Investors in early rounds tend to expect a SAFE. Notes turn up when the investor wants the protection of debt, when the money is a bridge to a round that is already in sight, or when the investor is a friend who wants the paper to look like a loan. Either way, read the cap, the discount and any side letter before anything else.

Arabella's library carries four SAFE forms: post-money cap only, post-money cap and discount, pre-money cap only, and pre-money cap and discount. It also carries the convertible note with a questionnaire that fills it, and the board consent approving a SAFE round.

Written by the lawyers who built Arabella. This is legal information, not legal advice for your situation, and reading it does not make us your lawyers. For a real dispute or a high-stakes decision, talk to a licensed attorney. More questions.