Not so Fast SAFEs! Convertible Debts Still Have a Place

If you are a founder, you may want to know what are SAFEs and convertible debts. While SAFEs have gained popularity, I believe convertible debt still have its position.

Patrick Mendes

10/23/20232 min read

man standing beside another sitting man using computer
man standing beside another sitting man using computer
What are the differences between SAFEs and Convertible Debt?

SAFEs are hot these days. Startups love the simple, standardized terms for getting early funding without complex debt. But convertible notes aren't going extinct just yet.

In fact, convertible debts still rule the roost in certain sectors like medical devices, pharma, and hardware. Why is that when SAFEs are so hip?

Well, those industries have been using convertible notes for decades before SAFEs were even invented. They've got history together. And in physical product worlds, the risks and costs are just different than for software startups.

With SaaS, you can launch an MVP fast and iterate. But when you're building a new pacemaker, the upfront costs are intense. And if your novel drug fails in trials, it's a disaster. The stakes are high.

So investors and founders in these sectors often want more control over the terms. Convertible notes allow customization to fit the risks, costs, and possibilities in play.

Meanwhile, software founders today barely remember a world before SAFEs, which just seems normal. And they love the simple standard terms to get funded fast.

So while SAFEs are clearly gaining steam, convertible notes aren't obsolete. They still help some sectors adapt funding to their specific needs and norms. Old school can be cool too!

What is SAFEs?

Simple Agreements for Future Equity (SAFEs) offer a streamlined approach to startup financing. These instruments are an alternative to traditional methods like convertible notes and preferred stock. SAFEs simplify the fundraising process by eliminating the need to set an initial valuation or interest rates. Instead, investors contribute funds to startups with the expectation of future equity in subsequent financing rounds, with specific terms negotiated within the SAFE agreement. Conversion into equity, typically preferred stock, occurs upon defined triggers like the next equity funding round or a company exit. Unlike convertible notes, SAFEs lack a maturity date, meaning repayment isn't mandatory if triggers aren't met within a set timeframe. The flexibility of SAFEs allows tailoring terms to suit the needs of both startups and investors, including discounts or valuation caps. These features make SAFEs an attractive option for early-stage investing.

What is Convertible Note?

Convertible notes are a financing tool commonly used in early-stage startup investments. They begin as debt agreements, with investors providing funds to a startup in exchange for promissory notes. These notes accrue interest and have a maturity date. The critical feature of convertible notes is their ability to convert into equity, typically preferred stock, when specific trigger events occur, most commonly the startup's next equity financing round. Conversion terms are predetermined, often with a discount or valuation cap that benefits investors. If the trigger event happens before the maturity date, the debt automatically converts into equity, obviating the need for repayment. While convertible notes are advantageous for startups as they delay the need to establish an early company valuation, they can be less predictable for investors, as the final conversion terms depend on the company's future valuation. These notes are a flexible financing option, but it's essential for both startups and investors to carefully negotiate and document their terms.

"We are dedicated to supporting early-stage founders navigate market entry journey "

Patrick Mendes

Business Consultant