Most first checks a startup takes don’t come with a share price, because nobody can defend one yet. Instead the founder and the investor agree on a rule for settling the price later: when a priced round happens, the early money converts into shares on terms set today. The two instruments built for this are the convertible note and the SAFE, and the difference between them is mostly about what happens if that priced round is slow to arrive.
The One-Line Version
A convertible note is a loan that is expected to convert into equity. A SAFE (Simple Agreement for Future Equity) is a right to future shares that is explicitly not a loan. Y Combinator, which created the SAFE, describes it on its documents page as “not a debt and not a loan — it has no interest and no maturity date,” and says it “converts into preferred stock, which happens automatically when you raise a priced round.”
| Post-money SAFE | Convertible note | |
|---|---|---|
| Legal nature | Right to future equity, not debt | Debt that converts to equity |
| Interest | None | Accrues (rate is negotiated) |
| Maturity date | None | Yes — a date the note comes due |
| Valuation cap | Usually, measured post-money | Usually, measured pre-money |
| Discount | Optional | Common |
| Document length and negotiation | Standard form, few variables | Bespoke terms, more to negotiate |
The Terms You Actually Negotiate
Valuation cap. YC defines it as “the highest valuation at which a SAFE converts into shares.” If the next round prices the company above the cap, the early investor still converts as if the company were worth only the cap, which is the reward for taking the risk first.
Discount. A discount, in YC’s words, “rewards early investors with a lower price than your startup’s next priced round.” A SAFE or note can have a cap, a discount, both, or neither; the investor typically gets whichever produces the lower price.
MFN (most favored nation). YC describes an MFN SAFE as one with “no valuation cap or discount” that instead takes the best terms of any SAFE the company issues later. It protects an investor who came in before the company knew what cap the market would bear.
Pro rata rights. On the YC form these sit “in an optional, standardized side letter rather than in the SAFE itself,” so granting them is a separate decision from signing the SAFE.
Why “Post-Money” Matters: The Math
The post-money SAFE, which YC made its standard form, measures the cap after every SAFE and convertible has converted. That makes one calculation easy: ownership sold = investment ÷ post-money cap, which is how YC’s own example works — on its deal page, YC says a $375,000 investment at a $15M post-money cap converts to 2.5% of the company.
A hypothetical, using round numbers:
- A startup raises $500,000 on a post-money SAFE with a $10M cap: 5% of the company.
- Six months later it raises $1,000,000 on another post-money SAFE with a $20M cap: another 5%.
- Total SAFE holders: 10% of the company, and the founders (and any option pool) hold the other 90%, before the priced round’s new money and any option-pool increase dilute everyone further.
The practical lesson is that each post-money SAFE you sign has a fixed percentage attached to it, so the total you’ve given away is visible at a glance. YC’s deal page also notes the order of operations at conversion: SAFEs convert into preferred shares, the option pool is created or increased, and then new money is invested — which is why the priced round dilutes the SAFE holders’ stake along with the founders’.
How a Convertible Note Differs in Practice
Because a note is debt, three extra things happen that a SAFE avoids:
- Interest accrues. The principal the investor converts isn’t just the original check — it’s the check plus accrued interest. Hypothetically, a $500,000 note at 8% simple interest that converts 18 months later converts as roughly $560,000 of principal and interest, not $500,000 (interest = $500,000 × 8% × 1.5 years = $60,000).
- There’s a maturity date. If the priced round hasn’t happened by then, the investor can technically demand repayment, and the company and investor have to negotiate an extension or conversion. A SAFE has no such cliff.
- It sits on the balance sheet as debt, which can matter to banks, to accountants, and to the optics of an early cap table.
None of this makes notes bad — some investors, particularly outside the U.S. or in structured angel groups, prefer the creditor protections — but it’s the main reason the SAFE became the default form for early rounds in the U.S.
Which Should a Founder Choose?
Reasons founders default to the SAFE: it’s a standard form with few moving parts, it carries no repayment risk, and with a post-money cap the dilution is a single division. Reasons to consider a note: an investor insists on it, or the deal is large enough that you want interest and maturity terms written down for both sides. Whichever you pick, there are three habits worth keeping:
- Track every instrument in one cap-table model, with the cap, discount and conversion math for each, before you sign the next one.
- Raise against a target percentage, not just a target dollar amount. Under a post-money SAFE, each check at a given cap is a percentage of the company.
- Know what your priced round will do on top. The conversion order above means the option-pool top-up and the new money both land after the SAFE percentages are set.
Common Mistakes
- Treating a SAFE as a free pass. It has no maturity date, but it still converts into a real percentage of the company — often several of them, stacked.
- Mixing pre-money and post-money SAFEs without modelling both. The two measure the cap differently, so the same dollar figure means different ownership.
- Ignoring interest on a note. The share count at conversion is based on principal plus interest, which grows the longer the priced round takes.
- Granting MFN or side-letter rights casually. Each one changes what later investors will accept, so they belong in the cap-table model too.
- Skipping legal review because the form is “standard.” The form is standard; your cap table, jurisdiction and side deals aren’t.
FAQ
Is a SAFE a security?
Yes — a SAFE is an agreement to issue equity, so offering one is a securities offering and has to fit an exemption. Your startup lawyer will normally handle that, usually under an exemption for private placements.
Do SAFEs ever convert without a priced round?
On YC’s form, conversion is triggered by an equity financing, and the form also covers liquidity events like an acquisition, where the holder is entitled to a payout or to convert. Read the specific form you’re signing for the details of each trigger.
Can a company use both a SAFE and a note?
Yes, and it happens — but stacking different instruments with different caps, discounts and interest makes the conversion math harder to model, so it’s worth building the cap table scenario before you do.
What’s a reasonable valuation cap?
There is no single correct number; caps are negotiated and have moved with the market and the sector, and published benchmarks differ by data source and by round size. Treat any benchmark as a range to sanity-check against, not a rule.
A SAFE’s conversion percentage is exactly the kind of number that feeds a later startup valuation and the seed round that eventually prices it; how a priced round then sets the strike price on employee grants is covered in the 409A valuation guide, and the founder-side split before any outside money comes in is in the equity split and vesting guide. Brad Feld and Jason Mendelson’s Venture Deals is a useful plain-English reference for how these instruments behave once a term sheet shows up. This guide is general information, not legal advice; have a startup lawyer review any instrument before you sign it. More in the finance section on FutureSharks.
