Seed Financing

Why Founders Use Notes and SAFEs

• Speed and Simplicity: Easier and faster to close than equity financings.
• Lower Costs: Fewer documents and negotiations keep legal and administrative expenses down.
• Flexibility: Defers setting a valuation until the company is more mature.
• Market Familiarity: Well-understood by most angels, accelerators, and seed investors.

Convertible Notes vs. SAFEs

• Convertible Notes:
  
   
  • Debt that converts into equity at a future financing or exit.
   
  • Includes interest (typically 4–8%) and a maturity date when repayment may be due.
   
  • Viewed as slightly more investor-friendly because of repayment rights.
 
• SAFEs:
  
   
  • Contractual right to receive equity at a future financing.
   
  • No interest, no maturity date, and no repayment obligation.
   
  • Viewed as more founder-friendly but very common with early-stage investors.

Key Terms to Understand

• Valuation Cap: The maximum valuation at which the note or SAFE converts, protecting investors if your valuation skyrockets. Back of the envelope, divide the principal amount by the valuation cap to get an estimate of ownership percentage.
• Discount Rate: Upon the conversion of the note or SAFE, the insrtument converts at a discount (often 10-20%) to the price of stock in the equity financing.
• Conversion Events: Typically convert at the next preferred stock financing or exit.
• Interest & Maturity (for Notes): Interest accrues until conversion; maturity dates often range from 12 to 24 months.

Process Overview

1. Term Sheet: Agree on basic economics—amount raised, cap, discount, and other key terms.
2. Documentation: Draft and sign convertible note purchase agreements or SAFEs.
3. Closing: Funds transfer, instruments are issued, and records updated.
4. Post-Closing Compliance: File securities notices (Form D, state “blue sky” filings) and update your cap table.

Pros and Cons

For Founders:

·      Fast, inexpensive, defers valuation.

·      Can create cap table complexity if too many different caps/discounts are issued.

For Investors:

·      Protection through caps and discounts, sometimes maturity/interest.

·      Less control and fewer rights compared to equity rounds.

‍Do I need to set a valuation now?
No. Notes and SAFEs defer the valuation until your next priced round, which makes early fundraising easier.

Which is better—note or SAFE?
It depends. Notes give investors repayment rights, SAFEs are simpler and cheaper for founders. We help you weigh the tradeoffs.

What happens if I never raise a priced round?
With a SAFE, the investor may never convert. With a note, the maturity date may require you to repay.

How much can I raise this way?
There’s no fixed cap, but larger raises often signal it’s time for a priced equity round.

Do I need to file anything?
Yes. Securities exemptions still apply, and you may need to file a Form D with the SEC and state filings.