When should I use convertible notes and SAFEs?
Takeaway: Convertible notes and SAFEs (mostly SAFEs) are the standard instruments for early-stage fundraising, designed to be a fast and cost-effective way to raise seed capital before your company is ready for the complexity and expense of a priced equity round.
When your startup is ready to raise its first outside capital, you face a key structural question: should you sell stock to investors at a fixed price now, or should you use a simpler instrument that pushes that valuation decision into the future? For the vast majority of early-stage startups, the answer is to use a convertible instrument.
The two dominant convertible instruments in the startup world are the convertible note and the SAFE (Simple Agreement for Future Equity). These are the essential tools for raising a "seed" or "pre-seed" round of funding. They are designed to be a fast, efficient, and cost-effective bridge to get your company from its initial launch to its first major priced financing (your Series A).
The Problem with an Early "Priced Round"
Why not just sell stock at a set price from day one? The reason is that a formal "priced round" is a complex and expensive undertaking.
The Valuation Dilemma: It is incredibly difficult to place a specific valuation on a brand-new company that may have no product, no revenue, and no metrics. A lengthy negotiation over valuation at this stage can be a major source of friction.
High Legal Costs: The legal documents for a priced round of preferred stock are extensive, complex, and expensive to negotiate.
The Convertible Instrument Solution
Convertible notes and SAFEs elegantly solve this problem by deferring the valuation conversation.
How They Work: An investor gives your company cash today. In return, the company does not give them stock today. Instead, it gives them a contractual right to receive stock in a future financing round. The instrument "converts" into the same class of preferred stock that the new investors are buying in that future round, typically at a discount to the price they pay.
The Benefit: This allows you to raise capital quickly and efficiently without having to go through a difficult valuation negotiation or draft a complex set of legal documents.
The Primary Use Cases
The First Round of Capital (Seed/Pre-Seed): This is the classic use case. You are raising your first $500k to $2 million to build your initial team, develop your MVP, and find early signs of product-market fit. The goal is to use this capital to hit the key milestones that will allow you to raise a formal Series A round.
A "Bridge" Round: Convertible instruments are also often used for small "bridge" rounds between major priced financings. If your company is running low on cash but is close to a major milestone that will unlock a larger Series B, you might raise a small convertible note from your existing investors to give you a few extra months of runway.
Once your company has matured enough to attract institutional venture capital for a Series A round, you will graduate from convertible instruments to a formal priced round. But for that crucial first injection of capital, convertible notes and SAFEs are the indispensable tools that power the entire early-stage startup ecosystem.
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.