What transactions force automatic conversion of convertible notes or SAFEs?
Takeaway: Both convertible notes and SAFEs are designed to automatically convert into equity upon a single, specific event: the closing of a priced financing round where the company sells shares of a new series of Preferred Stock.
A convertible note or a SAFE is a temporary instrument, a bridge designed to get your startup from its seed stage to its first major financing. The entire agreement is structured to "trigger" an automatic conversion into equity when that future financing event occurs. Understanding the precise nature of this trigger is essential for both founders and investors.
In the modern startup ecosystem, the trigger for both convertible notes and SAFEs has become highly standardized. The conversion is not optional; it is a mandatory and automatic event that occurs upon the closing of the first priced round of financing.
The Conversion Trigger: An Equity Financing
The conversion event is defined in the agreements as an "Equity Financing." This is a formal, priced round where the company sells a new series of Preferred Stock to investors (e.g., a Series A Preferred Stock financing). The moment the company closes on this sale of preferred stock, the automatic conversion of all outstanding convertible notes and SAFEs is triggered.
Why is a "Priced Round" the Trigger?
The entire purpose of a convertible instrument is to defer the valuation discussion. The instrument cannot convert until a formal, third-party valuation has been set. The "Equity Financing" is the event that sets that price.
Establishing the Price: The negotiation between the company and its new lead investor in the Series A round establishes a formal "price per share" for the preferred stock.
The Conversion Price: This new price per share is then used as the benchmark for calculating the conversion price for the convertible notes and SAFEs, after applying their respective valuation caps or discounts.
The conversion is designed to happen in the context of a legitimate, professionally-led financing round, where the valuation and terms have been set through a real, arms-length negotiation.
The Conversion is Automatic and Mandatory
Once the company closes on the Equity Financing, the conversion of the convertible notes and SAFEs is automatic and mandatory. The noteholders and SAFE holders do not have the option to refuse the conversion. Their contractual right to future equity is automatically exchanged for shares of the new series of preferred stock, at a price determined by their specific valuation cap or discount, and they become stockholders in the company alongside the new investors.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.