SAFE and Convertible notes can be used to generate investment for startups. SAFE notes are short for Simple Agreement for Future Equity, which basically allows investors to purchase shares for the future through convertible security. You can turn this in for shares in the future when the company raises the price.
Companies usually provide SAFE and Convertible notes when they want to generate investment. However, you may want to know the difference between the two to provide your potential investors with the two options.
SAFE allows your investors to buy shares for a later stage, whereas Convertible notes are debt-based investments. Convertible notes are much like loans that must be paid later through cash or shares.
The following article will discuss the two in detail and analyze the differences to help you decide.
The Differences Between SAFE and Convertible Notes
The main differences between SAFE and Convertible notes include the following:
1. Convertible Notes Are Like Loans
Unlike SAFE notes, Convertible notes are based on debt with an applicable interest rate. If an investor and a startup are involved in a Convertible note transaction, the startup will ultimately need to pay off the amount and the interest rate.
SAFE notes aren’t loan-based and are much more like a regular investment into equity that can be transacted later. These will not have an applicable interest rate and will not act as a liability for you in the future.
2. SAFE Notes Do Not Mature
SAFE notes do not reach a maturity date, so startups can be relaxed regarding the SAFE note-based investments in their company.
Unlike these, Convertible notes reach maturity after a while. When they do, the company will either have to pay the amount with interest or add it to their stock.
3. SAFE Notes Are SAFE!
SAFE notes will be converted into equity the next time financing occurs. This means you can predict when it will be converted and keep track.
However, Convertible notes can convert at different events, such as the following:
- If the startup and the investor both agree on the conversion
- If the startup has raised the minimum amount in that time
- When the Convertible note has matured
Other instances can also trigger conversion.
SAFE and Convertible Notes: Which to Choose?
If you have recently come up with a startup idea and are wondering which kind of investment route to choose, the following points should be considered.
Pros of SAFE Notes
SAFE notes are much simpler to generate than Convertible notes, which involve lengthy documents. A SAFE note will not need you to draft a long document. You may generate a SAFE note agreement if you need a quick investment.
SAFE notes are ideal for people considering building a startup. It is much easier to gain investments through a SAFE note. However, if you are planning on using your profits to invest in other companies, you can go for convertible notes, as they will secure your investment.
Pros of Convertible Notes
Convertible notes are much more legally secure. You won’t need to meet multiple legal requirements or hire an entire legal team to raise funding through this option. This can help you save costs.
Convertible notes are ideal if you don’t want to attach value to your company yet. This is particularly beneficial for potential startups that haven’t yet determined how much revenue the product will generate.
Convertible notes are also much easier, so they are an ideal option for companies wanting to quickly generate funding for an idea that is in its early stages of development. If you are waiting for a deal to close or another factor before another round of equity, this is a great way to start.
A Convertible note is also a great option for tech-based startups who need to generate funds without having to worry about paying their investors back before their business reaches maturity. With these notes, funds are generated much faster.
SAFE Note vs. Convertible Note: Which Is Better?
There is no one answer to this. Some entrepreneurs believe that SAFE notes are a much better option simply because they are easier to generate and don’t require much paperwork or many rules and regulations in the future.
However, Convertible notes are a much better option for people who want to raise money faster to finance the early stages of their startup idea. At the end of the day, the best option is one that secures the future of both your founders and investors. SAFE notes are risky for a startup as if the idea doesn’t generate revenue in its early stages, you might experience a drop in equity. This can threaten your decision-making power.
If your startup idea is ambitious, consider Convertible notes at the start. Try to build the idea through the initial funding and switch to SAFE notes in the future once your idea has materialized.
How a Finance Expert Can Help
An accountant can help you generate funding through the best possible method. They can assist with the formation of a business model and match your ideas and forecasts to the best funding method. This includes deciding whether SAFE notes are a better option or if you should combine the two.
Accountants can also help you negotiate with investors at present or at a later stage. The terms you disclose to your funders will determine the ease with which you conduct business activity. This is an important thing to consider.
Cypher can help review your business model and help you fine-tune those details. This gets you valuable investments through your business story, be it through SAFE or Convertible notes. With experienced advisors well-versed in seed funding for tech-based startups, your Cypher finance team can provide you with the professional input required to raise from top-notch investors and VCs.
How to Treat SAFE and Convertible Notes (and How Can a CFO Help)?
Accounting for SAFE and Convertible notes can be made possible through an in-depth understanding of their inherent value. A financial expert can help you determine how to treat different investments on your financial records.
SAFE notes should always be considered as your equity as they provide investors with the opportunity to purchase shares that will mature later. However, Convertible notes are essentially a debt. Taxation, along with legal regulations, apply accordingly.
Remember that a SAFE note will always be added to your equity in the balance sheet until it is sold. However, a Convertible is treated as a debt, and the entry is more dynamic. With the right financial expert, recording and maintaining a record of these investments can help your business grow comfortably.
Final Thoughts
The best way to raise funding depends on your niche. Funding can determine the future of your business, so it is important to choose the right source. Your finance experts are especially useful in this regard, as they have sufficient wisdom to guide you towards the right route.
If you need financial analysis and strategy to determine the investing route you must take, consider hiring a financial expert. Cypher's experienced accounting experts analyze your statements and business plans with a trained eye and can take the burden of the numbers off your shoulders. This allows you to match investors that are relevant to your business niche.
