A SAFE note (Simple Agreement for Future Equity) is an investment instrument that gives investors the right to purchase equity in future financing rounds. Unlike traditional debt instruments, SAFEs do not accrue interest, have no maturity date, and convert to shares when specific trigger events occur. Created by Y Combinator in 2013, SAFE notes have become a standard tool for early-stage startup fundraising, offering simplified documentation and faster closing times compared to convertible notes.
What is a SAFE Note
SAFE notes function as forward contracts for equity. Investors provide capital to startups in exchange for the right to receive shares during a future priced funding round. The instrument does not accrue interest or require repayment, eliminating the debt burden that comes with convertible notes while preserving investor protections through valuation caps and discount rates.
Key characteristics of SAFE notes:
- No interest accrual - unlike convertible debt
- No maturity date - no repayment deadline
- No valuation required - defers pricing until Series A
- Conversion triggers - automatically converts during qualified financing
- Investor protections - caps and discounts preserve early-stage value
Y Combinator developed SAFE notes to address friction points in seed-stage fundraising. Before SAFEs, most early-stage investments used convertible notes, which created technical debt on the balance sheet. The original SAFE template was released in 2013 and updated in 2018 to address edge cases and improve clarity around conversion scenarios.
SAFE Note Structure and Terms
SAFE agreements contain several key provisions that determine conversion pricing and investor returns. The most common terms are valuation caps, discount rates, and most favored nation (MFN) clauses.
| Term | Function | Typical Range |
|---|---|---|
| Valuation Cap | Maximum conversion valuation | $5M - $15M |
| Discount Rate | Price reduction vs Series A | 15% - 25% |
| MFN Clause | Matching better terms | N/A |
Valuation Cap and Discount Rate
The valuation cap establishes the maximum company valuation at which SAFE investors can convert their investment into equity. Investors convert at the lower of the valuation cap or the actual round valuation (after any discount).
Example:
- Investor commits $100,000 with a $10M valuation cap
- Company raises Series A at $20M pre-money valuation
- SAFE converts at the $10M cap
- Investor receives 2x more shares than Series A investors per dollar invested
The discount rate provides an additional price reduction compared to the next priced round. With 20% being standard, a Series A price of $2.00 converts at $1.60, yielding 25% more shares per dollar invested.
When both caps and discounts exist, investors automatically receive the better conversion terms. The SAFE agreement automatically calculates both scenarios and applies the investor-favorable result.
Most Favored Nation Clause
The Most Favored Nation (MFN) provision allows existing SAFE holders to adopt the terms of any future SAFE issued with more favorable conditions. If a startup issues a new SAFE with a lower valuation cap or higher discount rate, previous SAFE holders can elect to convert under the improved terms.
Post-Money vs Pre-Money SAFEs
Y Combinator's 2018 update introduced post-money SAFEs, which provide more predictable dilution calculations. The key difference is when SAFE conversions are calculated relative to the Series A round.
Pre-money SAFEs convert based on Series A pre-money valuation, causing SAFE investors to dilute each other—making final ownership percentages less predictable. Post-money SAFEs (current standard) convert based on a defined post-money valuation cap where SAFE investors do NOT dilute each other, allowing founders to calculate exact dilution in advance.
| Aspect | Pre-Money | Post-Money |
|---|---|---|
| Dilution calculation | Unpredictable | Predictable |
| Multiple SAFEs | Dilute each other | Do not dilute each other |
| Current usage | Declining | Standard (2018+) |
Post-money SAFEs are now the market standard, providing founders with certainty about dilution before Series A closes.
SAFE vs Convertible Note Comparison
While both SAFEs and convertible notes convert to equity in future rounds, they differ fundamentally in their legal structure and financial characteristics. Convertible notes are debt instruments that accrue interest and have maturity dates. SAFE notes are equity forward contracts without debt characteristics.
| Feature | SAFE Note | Convertible Note |
|---|---|---|
| Legal structure | Equity forward contract | Debt instrument |
| Interest accrual | None | 2% - 8% annually |
| Maturity date | None | 18 - 24 months typical |
| Repayment obligation | No | Yes (if no qualified financing) |
| Balance sheet treatment | Equity-like | Liability |
| Documentation complexity | Simple (5 pages) | Complex (15+ pages) |
| Closing timeline | 1-2 weeks | 3-6 weeks |
SAFEs eliminate the debt classification of convertible notes. SAFE agreements typically span 5-7 pages with standardized language from Y Combinator templates, reducing legal costs to $1,000-$3,000 compared to $5,000-$15,000 for convertible notes.
Convertible notes typically mature in 18-24 months. If the startup hasn't raised a qualified financing round by maturity, the note becomes immediately payable or requires amendment. This creates pressure on founders to either raise capital on potentially unfavorable terms or negotiate note extensions. SAFEs eliminate this problem entirely by having no maturity date.
SAFE Note Conversion
SAFE notes convert to equity when specific triggering events occur. The conversion mechanics determine the number of shares investors receive and their final ownership percentage.
Primary conversion triggers:
- Qualified financing - priced equity round above minimum threshold ($1M-$2M)
- Liquidity event - acquisition, merger, or IPO
- Dissolution event - company liquidation or wind-down
Qualified financing conversion example:
- SAFE investment: $500,000
- Valuation cap: $10M
- Series A price: $2.00 per share
- Shares received: 375,940 shares (based on cap-derived conversion price)
SAFE investors automatically receive the conversion price that yields the most shares. In acquisition or merger scenarios, SAFEs typically convert immediately before the transaction closes, with investors receiving either equity in the acquiring company or cash proceeds based on their converted ownership percentage.
If the company dissolves before a qualified financing or liquidity event, SAFE holders stand in line after creditors but alongside common stockholders. Unlike convertible note holders, they have no priority claim as creditors.
Key Advantages and Considerations
SAFEs provide significant advantages for startups: faster closing (1-2 weeks vs 4-6 weeks), lower legal costs ($1,000-$3,000 vs $5,000-$15,000), no debt liability, no interest expense, and deferred valuation. The equity-like treatment keeps them off the balance sheet, which matters for venture debt covenants. SAFEs typically include minimal investor control provisions, preserving founder autonomy.
However, investors face increased risk exposure. SAFE investors have no repayment right, no interest accrual, and no creditor priority in liquidation. If a company operates profitably without raising institutional capital, SAFE holders may wait indefinitely for conversion.
Frequently Asked Questions
What happens if a company never raises a Series A? If a company never raises a qualified financing round, SAFE investors remain in a holding pattern indefinitely. Unlike convertible notes, there is no maturity date forcing resolution. The SAFE only converts during acquisition, dissolution, or if the company voluntarily triggers conversion.
How do multiple SAFEs interact during conversion? Under post-money SAFE structures (2018+ standard), multiple SAFEs do not dilute each other. Each converts based on its own terms independently. Under older pre-money SAFEs, multiple SAFE holders diluted each other because they converted based on the pre-money valuation including all SAFEs.
Can SAFE notes be transferred or sold? Standard SAFE agreements prohibit transfer without company approval. This protects startups from having unknown parties on their cap tables. Secondary sales of SAFEs are uncommon due to illiquidity and transfer restrictions.
Do SAFE investors get voting rights? SAFE investors have no voting rights until conversion. Once the SAFE converts to preferred stock during a qualified financing, investors receive the same voting rights as other holders of that stock class.
SAFE notes have become the dominant instrument for seed-stage fundraising because they simplify the early-stage investment process for both founders and investors. Understanding the key differences between SAFEs and convertible notes, along with the mechanics of valuation caps and discount rates, is essential for evaluating this critical instrument in startup financing. The shift to post-money SAFEs in 2018 resolved many of the dilution ambiguities that plagued earlier versions, making them the clear standard for modern seed rounds.