SAFE vs Convertible Notes: What Founders Must Know About Dilution and Timing

SAFE vs. Convertible Notes: What Founders Must Know About the Difference

For US startup founders, the first fundraising conversation is often a confusing swirl of new terms. You need capital to build, but the path is littered with complex startup fundraising instruments like SAFEs and convertible notes. Each carries long-term consequences for your ownership and control. The choice you make today directly impacts your dilution, future fundraising ability, and company governance.

This decision is not just a legal or financial formality; it is one of the most foundational choices you will make. It determines how your cap table will evolve and sets the precedent for your relationship with early investors. Understanding the precise difference between a SAFE and a convertible note for startups is the first step toward a successful fundraise that fuels growth without creating future complications. For a broader overview of all funding types, see the Funding Models and Instruments hub.

Foundational Understanding: The Three Paths to Early-Stage Capital

When raising your first capital, you generally have three primary options. The fundamental difference between them is whether you are selling ownership now or promising it for later. Understanding these paths provides the context for choosing between a SAFE and a note.

1. Priced Equity Round: This is the most traditional path. You and your investors agree on a company valuation today, which sets a specific price per share. They buy a defined number of shares, and the ownership exchange is immediate. A priced round provides certainty for everyone but involves significant legal work, due diligence, and negotiation. It often establishes a formal board structure.
2. Convertible Note: This is a loan to your company. Instead of being paid back in cash, the loan principal, plus any accrued interest, converts into equity during a future priced round. It is a debt instrument that functions as a bridge to a future, formally determined valuation. This is a common form of equity vs debt financing for startups.
3. SAFE (Simple Agreement for Future Equity): A SAFE is a warrant, which is a contractual right to purchase stock in a future financing round. Investors give you cash now in exchange for the right to receive equity later. Unlike a note, it is not debt. As a key piece of context, The SAFE (Simple Agreement for Future Equity) was created by Y Combinator and has become one of the most common early stage startup funding options.

Why Startups Choose "Unpriced" Rounds Over Priced Equity

Why would a founder choose the ambiguity of a SAFE or note over the certainty of a priced round? The decision comes down to efficiency, both in time and cost. Setting a valuation for a pre-revenue or early-revenue company is more art than science, making prolonged negotiation inevitable.

The pattern across early-stage startups is consistent: founders need to move fast. Unpriced rounds, like SAFEs and notes, allow you to defer the valuation argument until you have more market traction and performance data. This speed is a significant strategic advantage, allowing you to close capital from multiple investors on a rolling basis without a single formal "closing" event. It is also a financial one. The cost difference is stark: Legal fees for unpriced rounds (SAFEs, Notes) are typically $5k-$15k. In contrast, legal fees for a priced round are typically $30k-$100k+. For a founder managing cash flow in QuickBooks, that $25k-$85k in savings goes directly back into product development and extending runway.

The Core Difference Between a SAFE and a Convertible Note for Startups

At first glance, SAFEs and convertible notes accomplish the same goal: get cash now in exchange for equity later. However, the differences in their mechanics are critical. The most important distinctions are interest rates and maturity dates, which stem from their different legal classifications.

Legal Status: Debt vs. Warrant

A convertible note is legally classified as debt. This means the investor is a creditor, which gives them certain rights, such as being paid back before equity holders in a bankruptcy scenario. A SAFE is not debt; it is a warrant. This means it has no creditor rights, maturity date, or interest. This distinction also affects how the instruments are recorded on your balance sheet. For founders using QuickBooks, a convertible note is recorded as a liability, while a SAFE is typically categorized under equity. For more technical information, you can review professional guidance on accounting for convertible instruments from Deloitte.

Maturity Dates

Because it is debt, a convertible note must have a maturity date, a point in the future (typically 18-24 months) when the loan is due. If you have not raised a priced round by that date, the noteholder has several options. They could demand full repayment of their principal plus interest, potentially forcing an early-stage company into insolvency. They could also have the right to convert their investment into equity at a very low, pre-agreed valuation, causing massive dilution. While investors often agree to extend the date, this requires negotiation from a position of low leverage. This ticking clock creates real pressure and risk for the company. A SAFE has no maturity date and can sit on your cap table indefinitely until a conversion event occurs.

Interest Rates

As a loan, convertible notes typically accrue interest at 4-8% annually. This interest is usually not paid in cash; instead, it is added to the principal amount that converts into equity. This increases the total amount that turns into shares, giving the investor a larger stake and creating more dilution for founders and employees. A SAFE accrues no interest, simplifying the calculation of future ownership.

Geographically, convertible notes are seen more often outside of primary US tech hubs like Silicon Valley and with more traditional angel investor groups. The YC SAFE tends to dominate the tech startup ecosystem. For founders operating in the United Kingdom, local regulations and market norms differ significantly; review our Equity vs SAFE guidance for UK startups for relevant considerations.

Decoding Key Terms: Valuation Caps and Discounts

Whether you use a SAFE or a convertible note, the two most important negotiated terms are the valuation cap and the discount. These terms protect early investors from being diluted into insignificance if your company's value skyrockets before their investment converts.

The Valuation Cap

The valuation cap is the most heavily negotiated term in any unpriced round. It sets the maximum valuation at which an investor's money converts into equity. For example, if you raise funds with a $10 million valuation cap and your next priced round is at a $30 million valuation, the early investor’s money converts as if the valuation were only $10 million. This grants them a much larger ownership stake than the new investors, rewarding them for their early risk.

The Discount

A discount gives the investor the right to convert their investment into shares at a reduced price compared to the investors in the future priced round, typically a 10-25% discount. Most SAFEs and notes state that the investment will convert at the *lower* of the valuation cap price or the discounted price. This ensures the investor gets a preferential price regardless of the next round's valuation.

Pre-Money vs. Post-Money SAFEs: YC SAFE Explained

How the valuation cap is calculated is critical. This brings up the difference between a pre-money and post-money SAFE. A pre-money SAFE calculates the investor's ownership based on the company's value *before* their investment and any other SAFE investments are added. This was the original standard, but it created ambiguity because the founder’s ultimate dilution depended on the total amount raised on subsequent SAFEs.

To solve this, The Post-Money SAFE has been the YC standard since 2018. In a post-money SAFE, the valuation cap defines the company’s value *after* that specific SAFE investment is included. This provides absolute clarity on dilution for that specific investment. If you sell a $1 million post-money SAFE with a $10 million valuation cap, you have definitively sold 10% of your company on a post-money basis ($1M is 10% of $10M). This clarity is invaluable for founders because it isolates the dilution from each SAFE and makes cap table management predictable. For deeper modeling, see our guide to Advanced SAFE Terms: Valuation Caps and Discounts.

Modeling the Real-World Impact on Your Cap Table

One of the biggest challenges for founders is forecasting ownership when dealing with convertible instruments. How do you plan when you do not know exactly when or at what price SAFEs or notes will convert? For cash flow purposes, the approach is simple. The money you receive is cash in the bank. In your spreadsheet or accounting software like QuickBooks, you add it to your cash balance and use it to calculate your runway (Cash Balance / Monthly Burn Rate).

The complexity is in dilution modeling. The reality for most pre-seed startups is that financial modeling is done in spreadsheets. Let's consider a simplified numerical example to see how SAFEs work.

Example: Post-Money SAFE Conversion

• Your Startup: Raises a $100k post-money SAFE with a $10 million valuation cap.
• Future Priced Round: You later raise $2 million from a new VC at a $20 million pre-money valuation.

Here is how the SAFE converts:

1. Determine the Conversion Valuation: The SAFE converts at the *lower* of the valuation cap ($10 million) or the priced round valuation ($20 million). In this case, it converts at the $10 million cap.
2. Calculate SAFE Investor Ownership: The post-money SAFE promised the investor a percentage based on the cap. Their ownership is their investment divided by the post-money valuation cap: $100,000 / $10,000,000 = 1.0%.
3. Calculate New VC Ownership: The new VC is investing $2 million at a $20 million pre-money valuation. The post-money valuation for this round is $20M (pre-money) + $2M (new cash) = $22M. The VC's ownership is $2M / $22M = 9.09%.
4. Calculate Founder Ownership: The founders and team owned 99% after the SAFE converted. After the new round, their ownership is diluted by the 9.09% sold to the new VC. Their final ownership is 99% of the remaining (100% - 9.09%) = 90.0%.

Tools like the SAFE calculator from Carta can help with more complex scenarios. This simplified model allows you to run scenarios and understand the impact of your fundraising instruments.

Practical Takeaways: Making the Right Choice for Your Stage

Choosing the right fundraising instrument depends on your company’s stage, location, and the investors you are speaking with. Here is some general guidance for US-based tech companies in sectors like SaaS, Biotech, and Deeptech.

• For Pre-Seed Rounds: The post-money SAFE is overwhelmingly the standard in the US tech ecosystem. It is fast, cheap, and founder-friendly due to its clarity and lack of a maturity date. Most angel investors and early-stage funds are familiar and comfortable with it.
• For Seed Rounds: The conversation shifts as round sizes increase. A large seed round, where a convertible note or priced round might be considered, is around $3M+. At this stage, you may encounter investors who prefer the debt structure and creditor protections of a convertible note. If you have a clear lead investor and consensus on valuation, a priced round could also make sense to establish a clear governance structure.
• For Series A and Beyond: These rounds are almost always priced equity rounds. By this stage, the company has enough traction, revenue, and data to support a formal valuation process, and investors will require the governance rights that come with preferred stock.

When speaking with investors about an unpriced round, be direct. Key questions include confirming they are using a "post-money SAFE" to ensure clarity on dilution. Understanding these startup fundraising instruments is non-negotiable for building a sustainable company. If you are also weighing non-dilutive options, see our venture debt guide.

Conclusion

The difference between a SAFE and a convertible note for startups boils down to a core trade-off between simplicity and investor protection. The SAFE offers a streamlined, non-debt path to capital that prioritizes founder-friendliness and clarity on dilution, thanks to the post-money standard. The convertible note, as a debt instrument with interest and maturity dates, provides investors with more downside protection but introduces risk and complexity for the startup.

For most early-stage US startups, particularly in technology sectors, the post-money SAFE is the preferred tool. It allows you to secure capital efficiently and focus on what matters most: using that capital to build a valuable business. For broader context on your options, revisit the Funding Models and Instruments hub.

Frequently Asked Questions

Q: What are the main convertible note pros and cons?

A: The main pros of a convertible note are its speed and lower legal cost compared to a priced round. Investors often prefer them for their debt-like protections. The primary cons for founders are the maturity date, which creates repayment risk, and the accruing interest, which causes additional dilution upon conversion.

Q: What happens if a company with a convertible note does not raise another round before the maturity date?

A: If the maturity date is reached without a priced round, the investor typically has the right to demand repayment of the principal plus interest. They may also have the option to convert the debt into equity at a very low default valuation. Often, founders must renegotiate to extend the maturity date.

Q: Why do some investors still prefer convertible notes over SAFEs?

A: Some investors, particularly those outside of major tech hubs or with more traditional financial backgrounds, prefer convertible notes because they are debt instruments. This gives them a higher priority claim on company assets in a downside scenario, such as a bankruptcy, compared to SAFE holders.

Q: Is a post-money SAFE always better for founders?

A: For predictability, yes. A post-money SAFE provides founders with exact clarity on how much ownership is being sold with each investment. This prevents the "surprise" dilution that could occur with pre-money SAFEs if a founder raises more money on subsequent SAFEs than initially planned.