PRE-SAFE, POST-SAFE,
AND CONVERTIBLE NOTES

As a founder, you may be wondering how to choose between SAFE or convertible notes for your startup. Pre-SAFE (pre-money) notes are diluted by all funding and notes that occur before the maturity date. Post-SAFE (post-money) notes are only diluted by the funding round that triggers conversion. Pre-SAFE notes lead to less dilution for the founders and more dilution for the note holders while Post-SAFE notes lead to the opposite. Pre-SAFE notes are more difficult to calculate ownership when there are more investors and notes compared to Post-SAFE notes. In general, the reason to go with a note is a shorter time period to receive seed funding and lower associated cost, though the cost of a priced equity round has come down.

what are safe notes?

SAFE Notes (Simple Agreement for Future Equity) are agreements that allow for an investor to invest money in a company for future equity rather than having a priced round with a valuation placed on the company at the time of investment. SAFE notes can have either a cap or discount but more commonly they will have both to calculate the equity of the note holder when there is a priced round (generally Series A which for simplicity I’ll use for the rest of the post). The note will convert to equity at the time of Series A investment and the note converts at the lower per share price at either the valuation cap or the discount rate applied to the Series A share price.

Pre-SAFE vs Post-SAFE

Where Pre-SAFE and Post-SAFE notes vary is when and how the equity conversion is calculated. Pre-SAFE notes were originally created by Y-Combinator in 2013 to replace convertible notes by simplifying things. There is no interest or set maturity date of a SAFE note. Equity conversion for Pre-SAFE notes are calculated based on the outstanding shares pre-money of the notes, while Post-SAFE notes equity conversion happens post money of all investments prior to the Series A investment. Additionally, there are pro-ratas. For pre-SAFE notes they were included in the note, where the investor could purchase additional shares at the following funding round at the new valued price up to their original pre-money ownership stake. Where the post-SAFE notes differ is the pro-rata is an optional side letter that takes place at the next funding round. I.e. Series B instead of Series A.

What are convertible notes?

Convertible Notes are a debt instrument that convert into equity at either a qualifying event or at the maturity date. They also accrue interest (compounded annually) which converts into equity as well. Their conversion is pre-money so they will be diluted by other notes and other funding pre-Series A. Though it is rare for a convertible note to be repaid at the maturity date and are generally extended.

 

Pre-SAFE Note

PROS

Faster and generally cheaper to get funding than a priced round, pre-valuation funding means multiple notes will dilute each other and therefore less dilution for founders.

CONS

Can be difficult to calculate how much dilution there will be, especially if there are multiple notes and at different caps and discounts.

POST-SAFE Note

PROS

Faster and generally cheaper to get funding than a priced round, dilution is the easiest to calculate of all the notes.

CONS

Post-valuation funding leads to greater dilution for founders since multiple notes won’t dilute each other only the founders and existing common stock.

Convertible Note

PROS

Doesn’t automatically convert at the next priced round, pre-valuation funding.

CONS

The interest on the note leads to more dilution.

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