SAFE Note vs. Convertible Note: Which One is Right for Your Startup?

Raising early stage funding can be tough. Founders want to get money fast and investors want a fair deal. So, setting a valuation too early can be risky. That’s where SAFE notes and convertible notes come in.

These two funding instruments help startups raise money before determining an official valuation. They allow investors to put in capital in exchange for future equity. However, they work differently and have different benefits and risks for both founders and investors.

Understanding how each works is the key. Choosing the right one can impact your fundraising process, investor relationships, and long term financial structure. In this blog, we’ll break down SAFE vs. convertible note in simple terms and help you decide which is best for your startup or investment.

What Is a SAFE Note?

SAFE stands for Simple Agreement for Future Equity. Y Combinator introduced it in 2013 as a founder friendly alternative to convertible notes. The main goal was to simplify early stage fundraising by eliminating complex legal agreements and repayment risks.

A SAFE is not a loan or debt. It’s a legal contract in which an investor puts in funding to a startup in exchange for the right to get equity in the future. The conversion happens when the startup raises a priced equity round (a funding round where shares have a set value).

Key features of a SAFE note:

• No interest. Unlike convertible notes, SAFEs don’t accrue interest, because they aren’t structured as loans. This is good for founders as they don’t have to be worried about increasing debt obligations over time.
• No maturity date. There is no deadline to repay the investment or convert it into equity. The conversion happens when the startup raises a qualified financing round.
• Fewer complications. SAFE notes are simple, no negotiations over interest rates, repayment terms or loan extensions. This makes them faster to execute with lower legal costs.

When does a SAFE convert?

A SAFE note converts into equity when the startup raises a priced round (usually led by venture capitalists). The investor gets shares based on a pre-negotiated valuation cap or discount.

So, if the startup never raises a priced round, the SAFE might never convert. This means investors take on more risk compared to a structured loan. A convertible note is a short term debt that converts into equity. Unlike a SAFE, it starts as a loan and accrues interest over time. Instead of getting repaid in cash, the investor gets shares when the startup raises a priced round.

Key features of a convertible note:

• Accrues interest: Investors earn interest (usually 5-8% per year) on their investment, which increases the total amount converted into equity.
• Maturity date: Convertible notes have a deadline (often 12-24 months). If the startup doesn’t raise a priced round by then, the investor can request repayment or negotiate conversion terms.
• Potential repayment risk: If the startup doesn’t secure funding before the maturity date, the investor may demand repayment. This puts pressure on founders.

When does a convertible note convert?

A convertible note converts into equity under two common scenarios:

1. A Priced Equity Round: Same as a SAFE, it converts when the startup raises a qualified financing round, often with a discount or valuation cap.
2. At Maturity: If the startup doesn’t raise a priced round by the maturity date, the investor can either:
   
   • Extend the note’s maturity.
   • Convert it into equity at an agreed valuation.
   • Demand repayment (though most startups negotiate conversion instead).

Convertible notes offer investors more protection since they have a maturity date and interest. But they require more legal structuring than SAFEs.

SAFE Note vs. Convertible Note: The Key Differences

When Should You Use SAFE vs. Convertible Note?

The choice between a SAFE note and a convertible note depends on your funding needs and investor preferences. Here’s when each option makes sense:

Use a SAFE Note If:

• You need quick and easy funding with minimal legal complexities.
• You expect to raise a priced round soon and don’t want repayment obligations.
• Your investors are okay with an open-ended conversion timeline.

Use a Convertible Note If:

• Your investors want more security with interest and a maturity date.
• You want a structured agreement with debt protection.
• You need more time before raising a priced round.

How do Valuation Caps and Discounts Work?

Both SAFE notes and convertible notes often have valuation caps and discounts to benefit early investors.

• Valuation Cap: This sets a maximum valuation at which an investor’s note converts into equity, so they get a better deal than later investors.
• Discount Rate: A percentage discount (usually 10-20%) applied to the share price when the note converts, so investors get more shares for their investment.

These terms balance risk and reward for early investors and give startups flexibility in fundraising.

Legal Considerations for Convertible Note vs. SAFE

While both are designed to simplify fundraising, legal considerations apply:

• SAFE Notes: Simpler agreements but may need legal review to ensure they align with investor expectations.
• Convertible Notes: More structured and require negotiation, especially for repayment clauses and interest terms.

It’s always a good idea to work with an attorney experienced in startup financing to ensure all terms are clear and beneficial for both parties.

Why Choose a SAFE Note?

Startups love SAFE notes, because they are fast, flexible and founder-friendly. They are a good choice if:

• You don’t want to deal with interest rates or repayment deadlines: Since there is no maturity date or debt component, there is no need to worry about repayments.
• You think your startup will raise a priced round soon: SAFEs only convert when you raise equity financing, so they work best if you expect to grow quickly.
• You want a simple agreement with no legal complexities: SAFE notes are easy to execute, reducing fundraising delays and legal fees.

Downside: Since SAFEs have no maturity date or interest, investors take more risk. If your startup never raises a priced round, they may never see a return on their investment.

Why Choose a Convertible Note?

Convertible notes give investors more security and are good if:

• Investors want interest on their investment: The interest accrues and increases their ownership when the note converts.
• You expect to raise a priced round but need short-term funding: Convertible notes provide a structured way to bridge the gap until a major investment round.
• You are okay with legal complexities and potential repayment obligations: While convertible notes add structure, they also come with more legal costs and maturity deadlines.

Downside: The maturity date can pressure startups to raise funds or repay investors, which may be difficult if growth is slower than expected.

Tax Implications of SAFE Note vs. Convertible Note

Both SAFE notes and convertible notes have tax implications for founders and investors. Here’s what to consider:

• SAFE Notes: Since they’re not debt, they don’t create tax liabilities for the startup until conversion. However, investors should be aware of capital gains tax when their equity appreciates.
• Convertible Notes: Interest accrual means the startup has to report the interest expense, and the investor has to report interest income. And if the note converts at a discounted valuation, the investor has to deal with tax on the gain.

Talk to a tax expert before you structure your funding round to avoid surprises.

Convertible Note vs. SAFE: Which One Is Right for You?

So, the next question that needs to be answered is—Convertible Note vs. SAFE: which one works for you? 

 Here’s a quick way to decide:

• If you’re a founder looking for speed and simplicity → SAFE Note
• If you’re an investor seeking more security and structure → Convertible Note

Many startups today prefer SAFE notes because they remove the stress of interest payments and deadlines. However, some investors prefer convertible notes as they provide a clearer timeline and financial return. It’s up to you what your preference is. 

Final Thoughts: Learn with Angel School

Both SAFE notes and convertible notes are useful for early-stage funding. Knowing the differences—safe notes vs. convertible notes in terms of debt vs. no debt, interest vs. no interest, maturity date vs. open-ended agreement—will help you choose the right one for your startup or investment.

For founders, a SAFE note is usually the easier and more flexible option. For investors, a convertible note provides more security and potential returns. The best deals are those that align with both parties’ expectations and risk appetites.

Want to learn more about startup funding and investing? Angel School’s Venture Fundamentals course teaches you everything you need to know about early-stage investments, including the difference between safe notes vs. convertible notes. Whether you’re a founder raising funds or an investor backing startups, we’ll show you the way. Join Angel School today and start your startup journey!