SAFE and Convertible Note Financing for NY Startups

Most early-stage startups raise their first outside capital through one of two instruments: a Simple Agreement for Future Equity (SAFE) or a convertible promissory note. Both let founders take in cash without immediately negotiating a valuation, deferring the pricing question until a later priced equity round. Both convert into equity on defined triggering events. But the two instruments differ in ways that matter to founders, investors, and any later acquirer or priced-round investor reviewing the cap table. SAFEs are not debt and do not accrue interest or have a maturity date. Convertible notes are debt with interest and a stated maturity. Each carries different rights, risks, and trade-offs. This guide explains how each instrument works, the standard economic terms, the choice between them, and the New York and federal securities considerations that frame any startup financing. For broader context on entity formation and the early-stage legal landscape, our starting a business in NY guide walks through the foundation, and our LLC operating agreement guide and LLC vs corporation guide cover the entity choice that frames any financing.

Why Startups Use SAFEs and Convertible Notes

When a startup raises capital, the conceptually clean path is a priced equity round: the company and the investor agree on a valuation, the company issues stock at that valuation, and the investor becomes a shareholder. The clean path is also expensive and slow. Priced rounds require lawyers on both sides, due diligence, negotiated stockholders agreements, valuation analysis, and often a board observer or director seat. For a $50,000 friends-and-family check, the legal cost of a priced round can consume a meaningful percentage of the investment, and the parties may not yet have enough business clarity to set a defensible valuation.

SAFEs and convertible notes solve this problem by deferring the valuation question. The company takes the money now under a short, standardized document, and the price for the equity is set at the next priced round, with mechanisms (caps and discounts, discussed below) that protect the early investor's interest in the meantime. The early investor gets the upside of investing early, the company gets capital without a valuation negotiation, and the priced round investors set the valuation when more information is available.

The two instruments also let companies raise capital from multiple investors on different timelines without renegotiating each instrument. A company can issue ten SAFEs over a six-month period, each on the same standard form, with each investor's terms tied to the same future priced round. The administrative simplicity is meaningful for early-stage companies that often have limited bandwidth for fundraising mechanics.

The trade-off is complexity at the next priced round. The conversion of multiple SAFEs and notes interacts with the priced-round terms in ways that can be subtle and that affect the cap table outcome materially. Founders sometimes do not fully appreciate the dilution implications until they sit down to model the next round. Careful analysis at issuance, and again at conversion, is essential.

How SAFEs Work

The SAFE was introduced by Y Combinator in 2013 and has been refined through several iterations. The current standard form, the post-money SAFE, is the dominant version in the market today. A SAFE is not debt. It is a contractual right to receive equity at a future date based on the terms of the SAFE, contingent on a triggering event. The investor pays cash now and receives the right to future shares, but is not entitled to interest, repayment, or any defined return until conversion.

The triggering events that cause a SAFE to convert are typically defined as: (a) the company's next priced equity financing above a defined size threshold, (b) a liquidity event such as an acquisition or initial public offering, or (c) a dissolution event. On a priced equity financing, the SAFE converts into shares of the same series the new investors are buying, at a price calculated based on the SAFE's valuation cap and discount terms. On a liquidity event, the investor receives a cash payment equal to the SAFE amount or the value of the shares the SAFE would have converted into, whichever is greater. On dissolution, the SAFE has a liquidation preference, but startup dissolutions usually return little or nothing to anyone.

The SAFE has no maturity date, no interest, and no obligation for the company to ever do a priced round. If the company never raises a priced round and never has a liquidity event, the SAFE can theoretically remain outstanding forever. In practice, this is rare because companies that do not raise capital usually do not survive, but the structural feature is meaningful: the SAFE investor has no contractual right to demand repayment.

Post-money SAFEs are also distinct from pre-money SAFEs (the original 2013 form) in how dilution is allocated. Under a post-money SAFE, the investor's ownership percentage is calculated after the SAFE itself converts but before subsequent SAFEs and the priced round. The structure makes the investor's resulting ownership more predictable and shifts more of the dilution from later financing onto the founders. Post-money SAFEs are generally more investor-friendly than pre-money SAFEs were, and the change has been a focus of negotiation in some cases.

How Convertible Notes Work

A convertible note is a promissory note that converts into equity rather than being repaid in cash. As a legal matter, it is debt: the company has borrowed money from the investor, owes interest at the stated rate, and must repay the principal and interest at the maturity date if the note has not converted before then. The note also typically includes events of default and acceleration provisions that apply to debt instruments generally.

Like a SAFE, a convertible note converts on a triggering event, typically a qualified priced equity financing. The conversion price is calculated based on the note's valuation cap and discount, similar to a SAFE. The mechanics of the conversion are slightly different because of the debt nature: accrued interest typically converts along with principal at the conversion price, and the note's principal balance is reduced or extinguished as part of the conversion.

The interest rate on a convertible note is typically modest, in the range of 4 to 8 percent. The interest accrues over the life of the note and converts into additional shares at the time of conversion. From the investor's perspective, the interest is a small bonus that compensates for the time between investment and conversion. From the company's perspective, the interest creates a balance sheet liability and slightly increases the dilution at conversion.

The maturity date is the most significant difference between a convertible note and a SAFE. If the company has not raised a priced round by the maturity date (typically 18 to 36 months after issuance), the note becomes due. The investor can demand repayment, which most companies cannot afford to make, putting the company in default. In practice, most maturity events are negotiated rather than enforced, with investors agreeing to extend the maturity, accept conversion at a defined valuation, or otherwise restructure. But the maturity event creates leverage for the investor that does not exist with a SAFE.

Valuation Caps and Discounts: The Economic Heart

The economic terms that distinguish one SAFE or convertible note from another are the valuation cap, the discount, and how they interact at conversion. Both terms protect the early investor against the downside of having invested at a higher price than warranted by subsequent events.

Valuation Cap

The valuation cap is a maximum valuation at which the SAFE or note converts, regardless of how high the next priced round values the company. If the cap is $5 million and the next priced round values the company at $20 million, the SAFE converts at the $5 million cap (giving the investor a 4x markup on conversion price relative to the new investors). If the next priced round values the company at $3 million, the SAFE converts at the $3 million priced-round price, because the priced-round price is below the cap and the cap is not binding.

The cap is the principal protection for the early investor against the upside scenario. Without a cap, an early investor who invests at $50,000 with the company eventually being worth $500 million would convert at the $500 million valuation, ending up with negligible ownership. The cap effectively says: in the upside scenario, the early investor's price is locked in at the cap, and the investor benefits from the upside.

Negotiation of the cap is one of the most contested points in any SAFE or note. The company wants a high cap to minimize dilution. The investor wants a low cap to lock in a favorable price. Caps are usually informed by comparable companies at similar stages, the size of the round, and the parties' relative leverage. There is no formula, only market norms and negotiation.

Discount

The discount is a percentage reduction off the priced-round price. A 20 percent discount means the SAFE converts at 80 percent of the priced-round price. If the priced round prices at $10 per share, the SAFE converts at $8 per share, giving the SAFE investor 25 percent more shares for the same dollar than the priced-round investors get.

Most SAFEs and notes include both a cap and a discount, with the conversion using whichever produces the lower (more favorable to investor) price. If the cap-implied price is $5 per share and the discount-implied price is $8 per share, the conversion uses $5 per share. The structure ensures the investor gets the better of the two protections without having to choose at issuance.

Discount-only instruments without a cap are sometimes used in very early arrangements, particularly with friends-and-family investors who do not negotiate hard. They are simpler but provide weaker protection in upside scenarios. Cap-only instruments without a discount are also used and are sometimes preferred by sophisticated investors who view the discount as redundant to the cap.

Choosing Between a SAFE and a Convertible Note

Both instruments achieve similar economic results through different legal structures. The choice between them turns on several considerations.

• Maturity pressure. Convertible notes have a maturity date that creates pressure on the company to raise a priced round. SAFEs have no maturity date. Companies that want certainty that they will not face a maturity event prefer SAFEs. Investors who want the leverage of a maturity event prefer notes.
• Interest accrual. Notes accrue interest, increasing the conversion amount over time. SAFEs do not. Investors who want the additional return prefer notes. Companies that want to minimize dilution prefer SAFEs.
• Investor sophistication and preference. Some investor groups prefer notes for the familiarity of debt. Others, particularly those used to YC-affiliated companies, prefer SAFEs. The choice often follows the investor base.
• Tax treatment. The tax analysis of SAFEs and notes can differ in ways that matter for some investors and companies. Notes are debt for tax purposes and produce interest income. SAFEs are not debt and do not produce interest. The tax treatment of conversion can also differ. Tax advice should be obtained for any meaningful financing.
• State law considerations. Convertible notes are debt for state-law purposes and may be subject to state usury laws and lender licensing requirements. SAFEs are not debt and do not raise these concerns. For New York issuers, both instruments are usable but the regulatory profile differs.
• Cap table cleanliness. SAFEs in the YC standard form are highly standardized, and a company with multiple SAFEs on the same form has a clean stack to convert at the priced round. Notes can vary more in their terms (interest rate, maturity, conversion mechanics) and can produce a more complex cap table.
• Defaults if the priced round does not happen. A maturing note creates a default risk if the company has not raised. A SAFE in the same circumstance has no default risk but also no leverage for the investor. Companies that are uncertain about their fundraising trajectory may prefer SAFEs for this reason.

Securities Law Compliance

SAFEs and convertible notes are securities under federal and state securities law. Issuing either instrument requires compliance with the registration requirements of the Securities Act of 1933 or an applicable exemption. The most common exemption used by startups is Regulation D Rule 506(b) (private placement to accredited investors with limited or no general solicitation) or Rule 506(c) (private placement to accredited investors with general solicitation permitted but with stricter verification of accredited status).

New York's Martin Act requires Form D filings and notice filings for offerings to New York investors. The Department of Law also imposes registration and disclosure requirements that apply to certain types of offerings. Compliance is generally straightforward for standard SAFE or note issuances to accredited investors but should be confirmed before any offering.

Issuance to non-accredited investors is much more complicated and generally avoided by sophisticated startups. The federal exemption that allows non-accredited investor participation requires extensive disclosure, including audited financials, that early-stage companies typically cannot provide cost-effectively. Most companies stick to accredited investors and accept the limitation on the investor pool.

Each issuance should also include the standard investor representations confirming accredited status, suitability, and understanding of risks. The company should retain a securities log of all issuances with investor representations and any required state filings. Sloppy compliance at the early stage creates problems at later financings, when due diligence by the new investors and their counsel will surface any issues.

Cap Table Implications and the Conversion Math

Founders often underestimate the cap table impact of multiple SAFEs and notes converting together at the next priced round. The conversion math is straightforward in principle but accumulates quickly across multiple instruments. Understanding the cumulative dilution before the priced round closes is essential to avoiding a surprise at signing.

Each SAFE or note converts based on its individual terms. An investor with a $5 million cap and a 20 percent discount, who put in $250,000, calculates conversion at the lower of: $5 million implied price, or 80 percent of the priced-round per-share price. The number of shares received depends on which is lower. If the priced round prices at a $10 million pre-money valuation, the SAFE converts at $5 million, giving the investor an effective doubled share count compared to a priced-round investor who put in the same amount.

When multiple SAFEs and notes convert at the same priced round, each is calculated separately, and the total dilution is the sum of all conversions. Founders who issued $1 million in SAFEs at varying caps may find that the total post-conversion dilution is materially higher than they expected, because the lowest cap drives the conversion price for that investor. Modeling the cap table at the priced round is the only way to know the actual outcome.

Some priced-round investors will not accept SAFEs and notes that have not been resolved before the priced round closes. The new investors want certainty about the post-money cap table, which means all SAFEs and notes have to convert at or before the closing of the priced round. The mechanical coordination is part of what the company's counsel handles in the priced-round closing.

For broader cap table and corporate context, our shareholder agreement guide covers the equity arrangements that come into play once the priced round closes, and our buy-sell agreement guide covers exit and ownership transition planning.

Common Mistakes Founders Make

Several recurring problems show up when SAFE and note financings are reviewed years later. Each is preventable with care at issuance.

• Issuing SAFEs at inconsistent terms. Each SAFE on different terms creates complexity at conversion. Standardize on a form and only deviate when the negotiation justifies it.
• Not tracking the SAFE stack. Companies sometimes lose sight of how many SAFEs are outstanding and on what terms. Keep a running cap table that includes all outstanding instruments and their conversion math.
• Setting caps without comparable analysis. Caps set without reference to comparable companies or the company's stage can be too low (giving away too much equity) or too high (failing to attract investors). Comparable analysis informs the negotiation.
• Ignoring securities law compliance. Failure to file Form D, failure to confirm accredited status, or solicitation that crosses into general solicitation under Rule 506(b) creates clean-up cost at the next financing.
• Allowing notes to mature. Notes that approach maturity without a priced round in sight require negotiation. Deal with maturity proactively rather than letting it happen.
• Not modeling the priced round. Founders should model the priced round before agreeing to SAFE terms. Understanding the dilution impact is part of evaluating whether the SAFE makes sense at the proposed terms.
• Mixing SAFEs and notes from different vintages. A company that has both pre-money SAFEs from years ago and post-money SAFEs from recently has a more complex stack than necessary. Consolidate or amend where possible to standardize.

How Agarunov Law Firm Helps with Startup Financings

At Agarunov Law Firm we represent startups, founders, and early-stage investors in seed and series A financings across New York and beyond. Our work includes entity formation and capitalization structuring, drafting and negotiating SAFEs and convertible notes, securities law compliance including Form D and state notice filings, cap table modeling, conversion analysis at the priced round, and ongoing corporate housekeeping. We also represent investors evaluating SAFE and note investments, including review of the company's capitalization, the cap and discount terms, and the conversion math under various scenarios. Our office at 30 Broad Street in Manhattan's Financial District serves clients throughout New York City and the broader region. For broader business law context, our New York business law practice page describes the full scope of representation we offer. For founders evaluating entity choice, our LLC vs corporation guide covers the foundational decision that frames any financing.

Frequently Asked Questions