Convertible Note vs SAFE vs Priced Round: A Founder's Decision Guide
The Three Ways to Raise Money
Most first-time founders get confused by the difference between:
- Convertible notes (debt that converts to equity)
- SAFEs (Simple Agreement for Future Equity)
- Priced rounds (actual equity sale with valuation)
Here's the complete breakdown.
SAFEs: The Simple Agreement
What it is: An agreement to give you money now in exchange for equity later at a future priced round.
Key characteristics:
- No interest rate
- No maturity date (unlike convertible notes)
- Converts at next priced round (or termination event)
- Typically has a cap (maximum valuation) and/or discount
Standard terms:
- Cap: $2M-$5M for seed rounds
- Discount: 15-25% off next round price
- Pro-rata rights: Usually included
The math problem:
Scenario: $500K investment, $3M cap, 20% discount
Next round: $10M pre-money, 1M shares existing
Without cap/discount:
- Investor gets: $500K / $10M × (1M + shares from new round)
With cap:
- Investor gets equity at $3M valuation instead of $10M
- Effective ownership much higher
With discount:
- Investor gets equity at 20% below $10M = $8M valuation
SAFE varieties:
- Pre-money SAFE (YC standard) - Converts at (Pre-money / shares) formula
- Post-money SAFE - Converts at fixed post-money valuation (newer model)
Convertible Notes: Debt in Disguise
What it is: A loan that converts to equity at a future priced round.
Key characteristics:
- Has an interest rate (typically 5-8% annually)
- Has a maturity date (typically 18-24 months)
- Converts at a discount and/or with a cap
- Is technically debt until conversion
The risks:
- If the company fails, debt holders get paid before equity
- If you can't repay at maturity, you may need to raise money specifically to repay
- Accrued interest increases your debt burden
Standard terms:
- Interest rate: 5-6% per year
- Maturity: 18-24 months
- Cap: $3M-$6M
- Discount: 15-25%
- Creditor rights: Subordinated to bank debt
Priced Rounds: Actual Equity
What it is: You sell actual equity at a set price per share.
Key characteristics:
- Sets an actual company valuation
- Creates a cap table with specific shares
- Requires 409A valuation (for IRS purposes)
- More expensive legally (need complete documentation)
The components:
- Pre-money valuation
- Price per share
- Number of shares being sold
- Post-money valuation (= pre-money + new investment)
Example:
Pre-money: $5M
Investment: $1M
Price per share: $1.00
Founder shares: 4M
Investor shares: 1M
Post-money valuation: $6M
Founder ownership: 80%
Investor ownership: 20%
Side-by-Side Comparison
| Feature | SAFE | Convertible Note | Priced Round |
|---|---|---|---|
| Interest | None | 5-8% annually | N/A |
| Maturity date | None | 18-24 months | N/A |
| Legal cost | Low ($500-2K) | Medium ($2-5K) | High ($10-20K) |
| Sets valuation | No | No | Yes |
| Cap table clarity | Low | Low | High |
| Conversion trigger | Next priced round | Next priced round | Immediate |
| Debt obligation | No | Yes (if no conversion) | No |
| Complexity | Low | Medium | High |
When to Use Each
Use a SAFE When:
- Pre-revenue or early traction
- Need money quickly
- Trust-based relationship (founder-friendly investors)
- Standard seed round ($250K-$2M)
- YC-backed or similar ecosystem
Use a Convertible Note When:
- Investor insists (some traditional VCs prefer notes)
- You need bridge financing
- Want to delay setting valuation
- Running a priced round is too expensive at this stage
- You have enough traction to negotiate note terms
Use a Priced Round When:
- Series A or later
- Institutional investors involved
- Need clear cap table for future hires/options
- Acquiring another company
- Existing shareholders want liquidity
The Conversion Math: A Practical Example
Scenario Setup
- Company has 4M founder shares
- Raising $500K
- Next round expected at $8M pre-money
Option A: SAFE with $4M cap
Cap: $4M
New shares = Investment / (Cap / Existing shares)
New shares = $500K / ($4M / 4M)
New shares = $500K / $1.00 = 500K shares
Post-investment shares: 4.5M
Investor ownership: 500K / 4.5M = 11.1%
Founder ownership: 88.9%
Option B: Convertible Note with 20% discount
Discount: 20%
Post-money valuation at conversion: $8M × 0.80 = $6.4M equivalent
New shares = $500K / ($6.4M / 4M) = $500K / $1.60 = 312.5K shares
Post-investment shares: 4.3125M
Investor ownership: 312.5K / 4.3125M = 7.2%
Founder ownership: 92.8%
Option C: Priced Round at $8M pre-money
Pre-money: $8M
Investment: $500K
Post-money: $8.5M
Price per share: $8M / 4M = $2.00
New shares: $500K / $2.00 = 250K shares
Post-investment shares: 4.25M
Investor ownership: 250K / 4.25M = 5.9%
Founder ownership: 94.1%
Comparison
| Option | Investor Ownership | Founder Ownership |
|---|---|---|
| SAFE (cap) | 11.1% | 88.9% |
| Note (discount) | 7.2% | 92.8% |
| Priced round | 5.9% | 94.1% |
Note: The SAFE with cap actually gave investor MORE ownership because the cap was below the expected $8M valuation. This is why caps matter.
The Cap vs. Discount Question
Which is better for investors?
- Cap is usually better if the company does well
- Example: If company raises at $15M, cap investor still converts at $4M = much higher ownership
Which is better for founders?
- Discount is usually better (lower effective valuation)
- But caps can be acceptable if set high enough
The negotiation:
Investor: "We want a $3M cap"
Founder: "Our comparable rounds are at $4M-$5M caps. We'll do $4M cap with 20% discount."
Investor: "How about $3.5M cap with no discount?"
Founder: "Deal."
The Post-Money SAFE Math Problem (YC 2018 Change)
YC switched from pre-money SAFEs to post-money SAFEs in 2018.
Old (pre-money) formula:
Post-money valuation = Pre-money + Investment
Ownership = Investment / Post-money
New (post-money) formula:
Post-money valuation = Fixed (stated on SAFE)
Ownership = Investment / Post-money valuation
Example:
Investment: $500K
Post-money SAFE: $5M (fixed)
Ownership = $500K / $5M = 10%
Why the change?
- Founders couldn't calculate their ownership until next round
- Post-money makes ownership explicit immediately
- More transparent for everyone
Red Flags to Avoid
In SAFEs:
- No cap (investor gets infinite upside at zero cost)
- Pro-rata rights that don't match priced rounds
- MFN clauses that trigger worse terms
In Convertible Notes:
- Interest rates above 8%
- Maturity dates under 18 months
- Personal guarantees from founders
- "Death spiral" conversion (price drops with every future round)
In Priced Rounds:
- Liquidation preferences over 1x
- Anti-dilution that isn't broad-based weighted average
- Excessive option pool (ask where the pool comes from - pre-money or post-money)
Decision Flowchart
Are you pre-revenue or early traction?
├── YES → SAFE (YC standard)
└── NO → Do you have institutional investors?
├── YES → Priced Round
└── NO → Is the investor traditional VC?
├── YES → Convertible Note (if they insist)
└── NO → SAFE
Key Takeaways
- SAFEs are the modern standard for seed/pre-seed rounds
- Convertible notes add complexity and risk - use sparingly
- Priced rounds are necessary for institutional investment
- Caps matter more than discounts for investor returns
- Post-money SAFEs are more transparent than pre-money
- Always get a lawyer before signing any financing document