What are some of the advantages and disadvantages of convertible notes and SAFE agreements? (2024)

FAQs

What are some of the advantages and disadvantages of convertible notes and SAFE agreements? ›

In general, SAFE agreements are considered more founder-friendly because they provide more flexibility and don't carry interest. Convertible notes tend to be more investor-friendly because the maturity date imposes more restrictions on founders.

There are also some disadvantages to convertible notes. First, they can be expensive if the company's valuation increases significantly between the time the notes are issued and when they convert to equity. Second, they can create dilution for existing shareholders if the conversion price is set too low.

Convertible note financings are simpler to document from a legal perspective. This means that they are generally less expensive from a legal perspective and that the rounds can be closed more quickly.

Lack Of Interest Payments: Unlike debt instruments, SAFE notes don't typically offer interest payments, which could be a disadvantage for investors seeking immediate returns. Investor Risk: In the case of a successful startup, investors might end up with a smaller equity stake compared to a fixed valuation.

Like SAFE, a convertible note allows the startup the option to delay the process of valuing their company until a later date. However, unlike a SAFE, a convertible note is an actual loan that the startup must pay back with interest.

The advantages of convertible bonds include income generation, capital appreciation potential, and downside protection. However, they may have lower interest rates compared to non-convertible bonds, and their market value may be affected by fluctuations in interest rates and the underlying stock price.

Cons of convertible bonds

Low yields: Relative to other corporate bonds, convertible bonds will offer a lower yield along with a conversion option. If the issuer's stock price never reaches the conversion price, the investor may instead hold the bond until maturity at a lower yield.

Convertible notes have several advantages: they are simple and fast to negotiate and execute without needing a valuation or complex legal terms; they defer the valuation discussion until the startup has more traction and data; they provide flexibility and optionality for the investor; and they can attract more ...

pros and cons: benefits of convertible notes

From a founder's perspective, the biggest benefit of convertible notes over an equity financing is speed. The note is generally a single document with simpler terms to negotiate, and without lots of conditions and warranties.

Why use SAFE agreement? ›

Flexibility and simplicity: SAFE agreements offer a high degree of flexibility, allowing startups to secure funding without the complexities of equity or debt financing. They are straightforward and quick to execute, which means you can raise capital faster and with fewer negotiations.

Flexibility: SAFE notes give startups more freedom due to the lack of maturity date. Equity: SAFE notes allow investors to convert their investments into equity. Little negotiation: SAFE notes are typically only negotiated based on cap.

The SAFE note promises equity to an investor at a future date, allowing the issuer to postpone the valuation of a company to a date when they will be better able to value the company.

What happens to a SAFE Note if the startup fails? If a startup that has issued SAFE (Simple Agreement for Future Equity) notes fails, the investors who provided funding through the SAFE will typically lose the money they invested.

Convertible bonds are typically issued by companies that have high expectations for growth and less-than-stellar credit ratings. The companies get access to money for expansion at a lower cost than they would have to pay for conventional bonds.

Like convertible notes, SAFE notes are intended to be converted to equity at a later date. However, SAFE notes contain several modifications that are intended to simplify the traditional process of convertible equity financing. Most importantly, unlike convertible notes, SAFE notes are not a loan or a debt instrument.

If a company raises money on a note and the company fails, the investors are creditors, getting money back prior to any shareholder and any creditor that doesn't have security or statutory preference. In almost every case, convertible note holders in these situations would be lucky to get pennies back on the dollar.

If the convertible note has not converted prior to the end of its term due a financing or sale of the company, the best option is usually to extend the term of the note for an additional year. Investors commonly use convertible notes to invest in startups because they are inexpensive and quick to draft.

Like convertible notes, SAFEs convert into stock in a future priced round. Unlike convertible notes, they are not debt and do not require the company to pay back the investment with interest.

In general, SAFE agreements are considered more founder-friendly because they provide more flexibility and don't carry interest. Convertible notes tend to be more investor-friendly because the maturity date imposes more restrictions on founders.