SAFEs, Convertible Notes and Priced Rounds: A Plain-English Primer
How the three most common ways to fund an early-stage company differ, and what investors and founders should understand before signing.
When a startup raises its first outside money, it usually does so in one of three ways: a SAFE, a convertible note, or a priced equity round. The names are confusing, but the ideas are simple once separated. This is a general overview, and the real terms of any deal should always be reviewed by a qualified attorney.
SAFE
A SAFE, or Simple Agreement for Future Equity, was introduced by the startup accelerator Y Combinator in 2013. An investor gives the company money now and receives the right to shares later, when the company raises a priced round. A SAFE is not debt, so it typically has no interest rate and no maturity date. Terms commonly include a valuation cap (a ceiling on the price at which the SAFE converts) and sometimes a discount to the price paid by later investors. These protect early investors for taking more risk.
Convertible note
A convertible note is a loan that is expected to convert into equity at a later round instead of being repaid in cash. Because it is debt, it typically carries an interest rate and a maturity date. It usually has similar conversion features to a SAFE, such as a cap and a discount. The maturity date can create pressure: if the company has not raised a priced round by then, the parties must extend, convert, or repay.
Priced round
In a priced round, the company and investors agree on a valuation, and the investors receive actual shares, usually preferred stock, in exchange for their money. Preferred shares often come with additional rights, such as a liquidation preference (investors get paid first in a sale) and information or participation rights. Priced rounds usually take more time and legal work than SAFEs or notes, but they settle ownership clearly from the start.
What to watch for
The key question for any of these is what the investment turns into later, and at what price. Stacking several SAFEs with different caps can lead to more dilution for founders than they expect, and a very low cap can mean an early investor receives a large share. Investors should model how their investment would convert under realistic scenarios before committing.
A note on who can invest
In the United States, many private investments in early-stage companies are limited to accredited investors under securities rules, and every offering has its own legal requirements. Anyone considering such an investment should understand the risks, including the real possibility of losing the entire amount, and should seek advice from a qualified professional.