Early-stage companies often raise money through one of three instruments: a SAFE, a convertible note or a priced round. Each turns an investor's cash into ownership, but on different timing and with different paperwork. This guide explains each one in plain English and the trade-offs founders tend to weigh. It is general information, not legal, tax or investment advice, and any instrument you plan to sign should be reviewed with your own attorney.
What a SAFE is
A SAFE, short for simple agreement for future equity, is a contract introduced by Y Combinator. The investor pays money now and receives the right to shares later, when the company raises a priced equity round. Until then, the investor holds no shares.
A SAFE is not a loan. It typically carries no interest rate and no maturity date, so there is no repayment deadline. Instead, it carries terms that decide how many shares the investor eventually receives, most commonly a valuation cap, a discount or both.
The common standard forms also cover a sale or wind-down before conversion. In a sale, the holder usually receives the greater of its investment or its as-converted amount. In a wind-down, it usually ranks behind creditors but ahead of common stockholders.
What a convertible note is
A convertible note is a loan designed to turn into equity instead of being repaid. Like a SAFE, it usually converts at a priced round, and it often includes a valuation cap and a discount.
The difference is that a note is debt. It carries an interest rate, and the interest typically accrues and converts into shares along with the principal. It also has a maturity date, when the note comes due if it has not converted. Notes usually define a qualified financing, a priced round of at least a stated size, that triggers conversion.
If maturity arrives without a qualifying round, the outcome depends on the terms and the holders. The parties may extend the date, the note may convert at a preset valuation, or the holders may be able to ask for repayment.
What a priced round is
In a priced round, the company sells shares at a set price per share, which establishes its valuation. In venture financings the shares are usually preferred stock, which carries rights common stock does not, such as a liquidation preference and certain approval rights.
Priced rounds involve more documents and more legal work: typically a term sheet, a stock purchase agreement, an amended certificate of incorporation, and agreements covering investor rights, voting and share transfers. For a walkthrough of those terms, see what is a term sheet.
Once the round closes, everyone knows the price, the share count and who owns what. Outstanding SAFEs and notes typically convert in that same round.
How a valuation cap and a discount work
A valuation cap sets the highest valuation at which a SAFE or note converts. If the priced round comes in above the cap, the early investor converts as if the company were valued at the cap, which means a lower price per share than new investors pay.
A discount gives the early investor a reduction to the price new investors pay. When an instrument has both, it typically converts at whichever produces the lower price. A cap is a ceiling on the conversion price, not a valuation.
An illustration with round numbers
The figures below are invented for illustration only. They are not typical or suggested terms.
- An investor puts $100,000 into a SAFE with a $5 million valuation cap and a 20 percent discount.
- The company later raises a priced round at a $10 million pre-money valuation. With 10 million shares outstanding before the round, new investors pay $1.00 per share.
- The discount price is $0.80 per share, 20 percent below $1.00.
- The cap price is $0.50 per share, which is $5 million divided by 10 million shares.
- The SAFE converts at the lower price, $0.50, so the investor receives 200,000 shares. A new investor putting in $100,000 at $1.00 receives 100,000 shares.
Had the round been priced at or below the cap, the cap would provide no benefit and the discount would set the price. Real conversion math is more involved, because the documents define exactly which shares count, often including options and other convertible securities.
Pre-money and post-money SAFEs
The original SAFE measured the valuation cap before counting any SAFE money, known as a pre-money SAFE. Y Combinator later introduced a post-money SAFE, where the cap includes the money raised on SAFEs but excludes the new money from the priced round.
With post-money SAFEs, each holder can work out its ownership going into the priced round from its investment and its cap, and each additional SAFE dilutes the founders and other existing holders rather than earlier SAFE holders. With pre-money SAFEs, SAFE holders dilute one another, and ownership is harder to pin down until the round closes. Neither version removes dilution. They distribute it differently, and in both cases the priced round then dilutes everyone.
The three side by side
- SAFE: not debt, no interest, no maturity date. Converts at a later priced round, usually with a cap, a discount or both. Short, often standard documents. Valuation deferred.
- Convertible note: debt with an interest rate and a maturity date. Converts at a later priced round, usually with a cap and a discount. Short documents, with interest and maturity to agree. Valuation deferred.
- Priced round: shares sold at a set price, usually preferred stock. Sets a valuation at closing. More documents, negotiation and legal work. Ownership is clear once it closes.
Trade-offs founders weigh
Each instrument trades speed and simplicity against clarity and structure. None fits every company, and the choice often depends on the stage and the investors involved.
Speed and cost
SAFEs and notes are typically faster to close. The documents are short and often standard, and money can come in on a rolling basis rather than at one closing. A priced round usually takes longer and costs more in legal work, because more terms are on the table.
Dilution clarity and stacking
A priced round tells everyone exactly where they stand. SAFEs and notes defer that answer, which means founders can sign several, often at different caps, without a clear picture of how much of the company they have sold. All of them convert in the same priced round, so the dilution lands at once, and the investors leading that round will look closely at what is already committed. Modeling every outstanding instrument in the cap table under a few priced round scenarios shows the likely outcome in advance.
If a priced round never comes
If the company never raises a priced round, a SAFE can stay outstanding indefinitely, and its holders own no shares until a financing, a sale or a wind-down triggers its terms. A note forces the question at maturity, when the company and holders must extend it, convert it or settle it, depending on its terms. For a company with limited cash, a note coming due can create pressure that a SAFE does not.
Terms vary, so read the documents
The labels describe the general shape of each instrument, not its exact terms. Two SAFEs can convert very differently depending on the cap, the discount, the pre-money or post-money form and added terms such as pro rata rights. Notes and priced rounds vary just as widely. Before signing any of them, review the document with an attorney and model its effect on ownership.
Preparing for your raise
If you are preparing for a raise and want your company ready for whichever structure you choose, SugarTime can help you get the pitch deck, data room and company structure ready before you meet investors. Start your application.