Convertible note vs SAFE note: What is the difference?

Finding funding for your startup can seem like a complex process, but it's an essential journey that every new business founder must go through.

There are various ways to finance your startup, including angel investors, venture capital firms, crowdfunding, loans, and even friends and family.

You might also have heard the terms 'SAFE note' and 'convertible note' being used, and you may be wondering what exactly they mean. While many people think that SAFE and convertible notes are two different things, the truth is that SAFE notes are simply a type of convertible note. Just like standard convertible notes and KISS (Keep It Simple Security notes) they are essentially an 'I owe you' that a startup issues to a founder. However, instead of being paid back in cash, the 'I owe you' is paid back in equity.

In this blog, we will take a deep dive into everything you need to know about convertible notes, including why SAFE notes can be a particularly beneficial fundraising tool for startups.

What is a convertible note?

There's no denying that securing a suitable early investor can take time. So, when you do finally come across a person or entity that is interested in investing in your idea, you want to make sure that the whole process is as seamless and efficient as possible.

One popular way of speeding up the investment process is to use a convertible note (sometimes known as convertible instruments).

Allowing startup founders to receive an investment without having to immediately issue any shares, it is called a 'convertible' because it is essentially a contract that can be converted into shares of your startup at a future date.

How are SAFE notes different?

Short for 'Simple Agreement for Future Equity', SAFE notes are currently the most popular form of convertible note used across the globe.

Originally created by US-based incubator YCombinator back in 2013, SAFE notes are specifically designed to be easy and straightforward to use, and very founder friendly.

Instead of hiring a lawyer to create unique investment documents, startups can simply download a SAFE note contract template for free from the internet, and format and adjust it to reflect their own personal agreement with their investor, with the support of their legal counsel to edit or add terms or clauses to the SAFE note.

This makes SAFE notes far more time-efficient than drafting traditional investment documents.

Benefits of SAFE notes

Free to download and use, SAFE notes save startups time, money, and hassle. Below are some of the main benefits of using this versatile form of convertible note.

Valuation caps

The valuation cap is a key component of a SAFE note. Setting a maximum conversion price for when the note will be converted into shares, a valuation cap is not a required part of a SAFE note contract, but they are often included. Offering advantages for both investors and startups, they provide valuable protection against excessive dilution of equity during future financing rounds.

No compulsory debt, loan, or interest

Unlike other forms of financing, convertible notes, including SAFE notes, do not necessarily have to burden startup founders with high levels of debt, interest rates, or loans that must be paid back.

However, the stipulations of each SAFE note is down to each individual founder and investor, and so the terms and conditions of each one can vary.

No compulsory maturity date

Another major benefit is that traditional SAFE notes do not necessarily have to have a maturity date.

In cases where there is no maturity date, startups that don't complete an equity funding round or a qualified financing round can relax in the knowledge that there is no obligation for them to start repaying their investors. In fact, in some instances, SAFE investments are never repaid, and the investor and founder instead come to a different arrangement.

However, it's also important to note that some investors do choose to add an 18-to-24-month maturity date to their SAFE notes, and that not all SAFE notes are maturity date free.

Money saving

Being able to use the free SAFE note template saves startup founders from forking out on the considerable cost of hiring a lawyer to compile an investment contract for them.

Although it is still advisable to hire a lawyer to review all your legal agreements and safe notes, the cost of hiring a lawyer to review, is considerably cheaper than hiring one to draft documents for you.

Speed and simplicity

Both convertible notes and SAFE notes allow startups to gain funding straightaway, and immediately start scaling up their business. No shares are issued when a SAFE note is signed, and there's no delay caused by waiting for the contract to be created.

At Hub71, we believe that SAFE notes can be hugely advantageous for new startups, and we have advised and guided many founders through the process of creating their own convertible note contract.

For more advice and information about convertible notes and startup fundraising, contact Hub71.