Transcript
Early founders need capital before the rigomearroll of a full equity round.
That's where safes and convertible notes come in. A price round is when you sell stock at a negotiated valuation.
Ownership is explicit. Everyone knows who owns what. Safes and notes skip that step. No valuation today. Fewer documents. Money moves quickly. Speed is the benefit. The cost is deferred dilution. To understand that cost, you need to understand the common safe flavors.
First, valuation cap only. This doesn't set valuation. It sets a cap used to calculate conversion later. You can estimate ownership by dividing the investment amount by the cap. Useful, but back of the envelope. It assumes no other cap table changes.
Second, discount only, just a percentage off the future price. This guarantees investors a discount, but leaves ownership uncertain until the round is priced.
Third is cap plus discount. The investor gets the better outcome. Whichever produces more shares. Good for investors, less so for founders.
Fourth, MFN only safes. MFN means most favored nation. You agree to give the investor any better terms you offer later. Very early on. This can help an investor move without negotiating economics. The footfall comes later. MFNs quietly follow the company and can upgrade old investors into better terms.
MFNs can be added to any safe flavor.
One practical note, regardless of flavor, try to keep everyone in the same terms. Different caps and discounts create cap table complexity which make outcomes harder to predict and can slow down your first round.
And a quick word on convertible notes. Like safes, notes convert into equity later, but they are debt. They include interest and a maturity date. An investor might require a note if they want more structure, but interest increases dilution and maturity creates a moment where something must happen.
Safes remove that pressure, which makes them popular and easy to overuse. Each safe feels small. Each decision feels temporary until everything converts at once and ownership recalculates. Founders finally see the full cost of speed.
Ask one question early. What ownership am I committing to if this works? Model dilution. Standardize terms. Don't confuse fast money with cheap money.
Safes and notes are great bridges. Be intentional about where they lead.
Seed Financing
Early fundraising often happens before your company is ready for a full equity round. To bridge this stage, startups commonly use convertible notes or SAFEs (Simple Agreements for Future Equity). These instruments let you raise money quickly without negotiating a full valuation, making them ideal for friends-and-family, angel, or early seed rounds.
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
- Term Sheet: Agree on basic economics—amount raised, cap, discount, and other key terms.
- Documentation: Draft and sign convertible note purchase agreements or SAFEs.
- Closing: Funds transfer, instruments are issued, and records updated.
- 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.
How Fahner Law Helps
We work with founders to:
- Evaluate whether a note or SAFE is the right fit for your round.
- Negotiate fair caps, discounts, and terms with investors.
- Draft and manage closing documents.
- Handle securities law compliance and post-closing filings.
- Keep your cap table clean and diligence-ready for future rounds.
FAQs
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.
Build, grow, & exit with confidence.
Thinking about raising your first round?
Fahner Law helps founders close note and SAFE financings quickly, cleanly, and at a flat rate.