Entrepreneurs often rely on funding from outside sources in order to get their business started. While you may think of traditional methods such as equity rounds, selling shares of stock, or getting a startup loan from a bank, these can have significant drawbacks. From requirements to pay back the money received to giving away your decision-making power, traditional methods are not always appealing. Additionally, some businesses are so unique and untested that many of the traditional methods are not options. Startup founders may look to SAFEs and convertible notes as potentially more viable options for raising capital. But which one should you use: SAFES vs. convertible notes? What is the difference between them? If you have other questions regarding startup funding, forming a business, or buying a franchise, one of our experienced Louisiana business startup attorneys at Business Law Group may be able to assist you. Call (504) 446-6506 to schedule a consultation and learn more about starting your own business. 

What Are SAFEs and Convertible Notes?

SAFEs and convertible notes are both funding models for Louisiana startups. The two are very similar but the differences between them are significant. Specifically, convertible notes are considered debt while SAFEs are not and convertible notes accrue interest while SAFEs do not. 

SAFEs 

SAFE stands for Simple Agreement for Future Equity. This agreement allows new entrepreneurs to attract investors while retaining equity in the company. The investors are paid back if the company succeeds, but if it fails, they are not required to. 

SAFEs are simpler and have fewer negotiation points than convertible notes. They offer one specific trigger event, like launching a Series A round, which Carnegie Mellon University indicates is the first round to use significant outside capital and often involves venture capitalists and angel investors. Lacking a maturity date, SAFEs also offer more flexibility for the company to achieve milestones and objectives before converting the agreement. 

Convertible Notes

Convertible notes are more like loans but instead of making interest payments regularly to repay the investment, the investors are promised the ability to eventually convert the notes to shares of the company when it is acquired or goes public. The University of Pennsylvania Carey Law School indicates that founders can also opt to pay back convertible notes with interest instead of converting the notes to shares. 

Convertible notes have lower interest rates and timelines than a traditional loan with the potential of a higher return on their investment than traditional equity investing. They are also flexible about when the investment becomes equity. However, they also do not have any guaranteed returns or benefits such as voting rights, asset appreciation, or dividend payments. They can also result in increasingly diluted stakes for existing investors if more convertible notes are made in future rounds of investing. 

Why Would Anyone Prefer a Convertible Note or SAFE Rather Than Hosting an Equity Round?

When considering SAFEs vs. convertible notes, or comparing these funding models to other traditional methods, one may wonder why someone would choose a SAFE or a convertible note over other options. One reason is that they allow pre-seed and seed-stage startups to raise the money they need without requiring a valuation. Traditional options, such as a bank loan, would require a valuation which may not be easy in such early stages of the business. 

Another reason for opting for SAFEs or convertible notes is that it allows the founder to postpone selling equity in the business. By retaining their equity, they keep their decision-making power for longer. This allows them to remain in charge and keep the business moving in the direction they want it to go rather than compromising with or being directed by investors. 

How Much Can You Raise On SAFEs Vs. Convertible Notes?

When a founder is considering SAFEs vs. convertible notes, an important factor may be how much money can be raised with each. SAFEs do not have a limit on how much money can be raised. However, investors may determine how much they wish to invest based on the company's valuation cap and how much they think their stake will shrink as the company continues to grow. 

Convertible notes do not have a specific limit on how much money can be raised, either. However, they are often limited by details such as qualified financing thresholds, caps, and discounts. If you are uncertain which type of funding may be more suited to your startup, a knowledgeable business startup attorney with Business Law Group may be able to assist you in reviewing both options and evaluating their abilities to meet your startup's needs. 

Are SAFEs Good for Startups?

Every startup is unique. Therefore, there is no one size fits all funding solution. Determining the right funding model for a particular startup should always be done on a case-by-case basis. 

However, SAFEs do have some advantages that can be beneficial to startups. SAFEs allow startups to delay the cost, paperwork, and time involved in traditional equity rounds while still being able to gain the venture capital they need immediately. Additionally, if the company fails, the founder is not required to pay investors back with a SAFE.

Which Do Investors Prefer: SAFEs Vs. Convertible Notes?

When deciding between SAFEs vs. convertible notes as a funding method, the decision may not be made by the founder alone. Founders and investors may negotiate to determine which method to use and the precise terms of the funding method once one has been chosen. Because neither method offers many protections to Louisiana investors, one may wonder whether investors prefer SAFEs or convertible notes. 

Both are securities that promise future privileges or activities. A benefit to convertible notes for investors is that they have a maturity date that allows them to call the note in and demand payment if nothing has happened by that date. Additionally, convertible notes have an interest rate, can be used by C-corps, and allow the investors to change the note to equity if the startup is acquired. While founders benefit because they are able to get the capital required without a complicated equity round, convertible notes may not be in their best interest as it is debt. This means if there are no future equity rounds, the founder may still be required to pay back the investment, which could result in bankruptcy. 

How Can a Business Startup Attorney Assist You?

Choosing a funding method, particularly in the earliest stages of a business when you are hopeful but not certain of success, can be a difficult decision. If you have not started a business before, you may also be uncertain about negotiating with investors and concerned about accumulating debt if the business were to fail. One of our skilled Louisiana business startup attorneys at Business Law Group may be able to assist you in deciding SAFEs vs. convertible notes, understanding the various terms that come with different funding methods, and negotiating with investors. Call (504) 446-6506 to schedule a consultation and learn more about how to get capital for your startup.