SAFE vs. convertible note: What’s the difference and which is better?

SAFEs and convertible notes are the two most popular financing structures for early-stage startups, largely because they’re relatively easy to implement and allow founders to delay giving up equity. 

Here’s what you should know about SAFEs vs. convertible notes to help you determine which makes the most sense for your business, including how they work, their downsides, and how they compare to traditional equity financing.

What is a SAFE?

A Simple Agreement for Future Equity (SAFE) is a type of convertible security that allows investors to convert their SAFE investment into equity at a future date. Typically, the SAFE converts at the next qualified funding round, such as a Series A round.

Introduced by Y combinator in 2013, SAFE notes were designed as a simpler alternative to traditional convertible notes. More specifically, SAFEs lack the debt characteristics of convertible notes, which can complicate early-stage financing.

In other words, SAFEs don’t accrue interest, have a maturity date, or require that you shoulder the administrative burden of compliance with debt regulations.

These features make them more attractive for founders who want the benefits of convertible notes—like quick access to capital, no need for a valuation, and delayed equity dilution—without the risks of taking on debt early in their startup journey.

As a result, SAFEs have become increasingly popular among startup founders. In 2024, 91% of early-stage startups used SAFEs to raise their pre-priced rounds, up from 64% at the beginning of 2020.

What is a convertible note?

A convertible note is another type of convertible security that allows investors to convert their investment into equity at a later date. Like with SAFEs, the conversion typically occurs at a future financing round.

Unlike SAFEs, convertible notes function as a debt instrument until they convert into shares of your company. A type of convertible loan, they accrue interest until their maturity date, though you usually don’t have to make any payments during that period.

However, if the maturity date arrives without a triggering event, the contract will generally require you to pay back the principal amount plus your interest charges.

In practice, many investors are willing to extend the maturity date, as they’re typically more interested in becoming an equity holder than collecting on debt.

As a result, the risk that you’ll have to repay what you borrowed is low, but you may dilute your equity more than you’d like if you repeatedly extend the maturity date and accumulate additional interest charges.

Because of its debt characteristics, the convertible note template has fallen out of favor with startup founders. They made up 42% of pre-priced rounds at the start of 2020 but accounted for just 9% of rounds in 2024.

However, they’re unlikely to disappear entirely, as some investors like the added security that comes with interest accrual.

SAFE vs. convertible notes vs. equity

SAFEs and convertible notes have a lot in common and offer early-stage startups a convenient way to raise capital quickly. Neither require you to have an established valuation or give up immediate equity in your company, making them easy to negotiate.

While only convertible notes have debt features, the two funding structures have much in common otherwise. 

Both allow investors to acquire discounted equity in your company at a later date, which they typically accomplish through the following types of conversion terms:

• Discount rate: This simply allows your investor to convert their investment into equity at a discounted price. For example, they might get to effectively purchase a certain amount of shares for 5% to 30% less than their future price.
• Valuation cap: This sets an artificial limit on your company’s valuation for the purpose of calculating how much equity your investor receives upon conversion. For example, if your company’s future valuation is $10M, but the valuation cap is $5M, your investor would convert their investment to shares as if your company were valued at $5M, effectively purchasing each share at a 50% discount.

Some convertible instruments offer favored nation terms, which let the convertible note holder or SAFE holder benefit from whichever approach---discount rate or valuation cap---is more beneficial.

While SAFEs and convertible notes are quicker, cheaper, and easier to execute, traditional equity financing is more suitable for later-stage funding rounds.

Equity funding involves selling shares directly to investors at a fixed price, which is appropriate once your company is better established and ready for a concrete valuation. However, it’s slower and more complex, requiring extensive negotiations.

SAFE note downsides

SAFE notes provide many advantages, which have helped them become the most popular way to raise capital during pre-priced rounds. However, they’re not necessarily right for every founder. Here are some downsides to consider:

• Unpredictable equity dilution: If your SAFE agreement includes a valuation cap—which most do—there’s no way to predict how much equity dilution you’ll experience upon conversion. If your future equity financing valuation is significantly higher than you expected, you could sacrifice a larger share of equity ownership than you’d like.
• Potential investor concerns: Founders increasingly prefer using SAFEs for pre-priced rounds, but some early-stage investors may not like them because they lack the investor protection convertible notes offer in the form of interest accrual and repayment requirements. Later investors may also worry about the dilution they’ll experience when the SAFEs convert.
• Company valuation calculations: Founders like SAFEs partially because they let you delay valuation discussions until your first priced round. However, if you want to use a valuation cap, you’ll have to calculate a pre-money valuation estimate anyway, so you may not save yourself as much work as you think.

Convertible note downsides

Many of the downsides that apply to SAFEs also apply to convertible notes. For example, both cause unpredictable equity dilution, which is not just a concern for you as the owner but can also potentially scare off future investors.

Similarly, convertible notes technically don’t require a formal company valuation, but you may need to calculate one anyway to inform a valuation cap.

However, convertible notes also have unique downsides due to their debt structure. They accrue interest, which compounds over time and increases the total amount that converts into equity, potentially leading to additional dilution.

In addition, while many investors are willing to extend maturity dates rather than demand repayment, the possibility of having to pay back the principal plus interest can cause financial pressure.

If your startup doesn’t complete a priced equity round before your convertible debt matures, you may find yourself scrambling to secure an extension or alternative funding.

Convertible notes are also considered liabilities until they convert. Not only can too much of that make your startup appear riskier to investors, but it also comes with additional accounting and tax burdens.

For example, you need to track interest accruals, report them properly on your financial statements, and maintain compliance with any applicable lending guidelines.

SAFE vs. convertible note tax implications

SAFEs and convertible notes have significantly different tax implications, which should factor into your decision when choosing between them.

From the issuer’s perspective, SAFEs are the simpler option. They don’t accrue interest, require repayment, or count as liabilities on your balance sheet, making taxes and financial reporting easier to manage.

In contrast, convertible notes function as debt until they convert into equity. The interest they accrue is typically tax deductible—even if you don’t make any payments—which requires careful record-keeping.

That can also be a burden for investors, who must also track the accrued interest and report it as taxable income. However, SAFEs actually tend to have more complex tax implications from the investor’s perspective.

Specifically, it’s tricky to determine whether SAFEs qualify for Qualified Small Business Stock (QSBS) treatment. A SAFE investor could potentially use it to exclude up to 100% of their capital gains on the stock from federal taxes. 

To qualify for QSBS treatment, investors must hold a stock for at least five years. Convertible notes can’t be considered equity until the triggering event, but SAFEs exist in a gray area before they convert, potentially starting the QSBS holding period sooner.

The Internal Revenue Service has yet to provide guidance on when SAFEs qualify as equity for QSBS purposes, so investors must decide which tax position to take: either start the holding period at the time of issuance or only after conversion.

How SAFEs and convertible notes impact company valuation

Company valuations typically consider fully diluted share counts, which include all outstanding shares and any potential shares that will be issued upon the conversion of convertible instruments, like SAFEs and convertible notes.

In other words, SAFEs and convertible notes increase the number of shares in circulation. While that may not affect your valuation directly, it does lower your price per share, complicating your cap table and leading to equity dilution. 

This can play a critical role in valuation negotiations. For example, founders may seek a higher valuation to minimize the dilution they experience and preserve more ownership for themselves.

Meanwhile, future equity investors might be incentivized to push for a lower valuation, allowing them to acquire shares at a cheaper price. That would help counteract any dilution they experience when each financial instrument converts.

Partner with Zeni for expert fundraising guidance

SAFEs, convertible notes, and traditional equity fundraising all have convoluted implications. Navigating their complexities can be overwhelming, especially if you don’t have a finance background.

The good news is you don’t need to hire an expensive, in-house team to handle these challenges. Zeni offers outsourced accounting and finance services specifically designed to support startups as they scale. Our comprehensive services include:

• Bookkeeping
• Tax planning and preparation
• Fractional CFO guidance

Our platform also includes a full suite of essential products, including business checking accounts, credit cards, and bill payment software. In addition, all of our offerings are enhanced by artificial intelligence, ensuring a streamlined experience.

Schedule a demo with Zeni today to learn how we can help you manage your finances and accomplish your fundraising goals.