Convertible instruments (notes and SAFEs) let you raise capital without setting a firm valuation, but you must understand the mechanics. The valuation cap is the most critical term, as it sets the maximum price for conversion. Modern post-money SAFEs have largely replaced notes in the US because they provide dilution clarity upfront and remove the risks of debt. Always model your dilution before you sign.
Key takeaways
- Default to post-money SAFEs for pre-seed rounds to simplify dilution math.
- The valuation cap is the most important term you will negotiate; model its impact.
- Understand that new money from a priced round (Series A) calculates its ownership *after* your notes/SAFEs convert.
- Never accept an uncapped note or SAFE. It misaligns incentives by punishing upside.
- Keep all convertible terms uniform across investors to avoid a "dirty" cap table.
- Hire an experienced startup lawyer. Do not try to save money here.
You need cash to hire, build, and grow. But you’re too early to have a defensible valuation. Welcome to the classic pre-seed founder’s dilemma. This is the problem convertible instruments—the convertible note and its successor, the SAFE—were designed to solve.
They let you take on investment now while pushing the hard valuation debate down the road. But these instruments, sold as “simple,” hide complexity that can cost you huge chunks of your company. Understanding the mechanics isn’t optional. It’s the difference between a successful Series A and a nasty surprise.
A convertible note is a loan. An investor lends you money, and instead of being paid back in cash, the loan converts into company stock during your next “priced” funding round (e.g., your Series A). Because it’s a loan, it has two features that can hurt you:
Interest Rate: The loan accrues interest (typically 2-8% annually). This isn’t paid in cash; the interest amount gets added to the principal and also converts to equity, adding to your dilution.
Maturity Date: The loan has a deadline (typically 18-24 months). If you haven’t raised a priced round by this date, the investor can demand their money back, potentially with a penalty. In a tough market, this can be a company-killer.
A SAFE (Simple Agreement for Future Equity) is not debt. It’s a warrant—a right to buy stock in a future priced round. Created by Y Combinator, it eliminates the two biggest risks of a note: there is no interest rate and no maturity date. An investor can’t demand their money back. For this reason, the SAFE has become the default for pre-seed funding in the United States.
Whether it's a note or a SAFE, your negotiation will center on three key terms. Master them. 1. The Valuation Cap
This is the most important term. The cap sets the maximum valuation at which your investor’s money converts into equity. Think of it as the highest price they’ll pay per share, regardless of how high your Series A valuation is.
A Concrete Example: An angel…
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Frequently asked questions
- What is a typical valuation cap for a pre-seed round?
- In the US, typical pre-seed caps range from $8M to $15M. This can vary based on the founder track record, market, and early traction.
- What is the difference between a pre-money SAFE and a post-money SAFE?
- A pre-money SAFE leaves your final dilution uncertain until you know the size of your next funding round. A post-money SAFE fixes the investor's ownership percentage the moment you sign, giving you clarity on dilution upfront (e.g., $500k on a $10M post-money SAFE is exactly 5%).
- Can a convertible note investor demand their money back?
- Yes. If the note reaches its maturity date before you raise a priced round, the investor can legally demand repayment. This is a key risk of notes and a primary reason founders now prefer SAFEs, which have no maturity date.
- Do convertible note investors get both the discount and the cap?
- No, they get whichever term gives them a lower share price. If your next round valuation is high, the cap is usually better for them. If the valuation is low or flat, the discount is more likely to be applied.
- How much do convertible notes cost in legal fees?
- Using standard documents, a simple convertible note or SAFE round can cost between $5,000 and $15,000 in legal fees. A priced equity round is significantly more expensive, often costing $50,000 or more.
