Reading time: 4 minutes

Australian startups are increasingly considering raising capital using a convertible note or a Simple Agreement for Future Equity (SAFE). Both a SAFE and convertible note are alternatives to a standard equity raise which sees an investor receiving shares in the startup in return for capital injection. Although there are similarities between a SAFE and convertible note, it is important to understand how they differ from both a traditional equity raise and from each other.

A convertible note has both debt and equity elements. Under a convertible note, an investor makes a loan to the startup which automatically converts into equity at a trigger event (in practice, the closing of a future equity round). Investors are rewarded for their early investment with a discount to the price per share paid by the equity round investors.

American seed accelerator, Y Combinator, created the SAFE. It’s similar to the convertible note, however, a SAFE is an equity structure, not a debt structure.

Key Features of a SAFE and Convertible Note

Convertible Note SAFE
Investment The investor loans money to the startup in return for equity if the company reaches a conversion event. The investor pays money to the startup in return for a contractual right to receive equity if the company reaches a conversion event.
Interest It is not a requirement to have interest payable on the loan. However, if it is included, the convertible note will specify the interest rate and method of calculation. This interest will often accrue and convert to equity along with the loan amount at the conversion or maturity event. As the SAFE is not a debt instrument, no interest is payable.
Conversion Event The convertible note will set out the event which triggers the loan to convert to equity. Commonly this will be an equity financing (a seed or series A round etc.) or exit event (sale, IPO, etc.) The conversion event is generally the same as seen in a convertible note.
Conversion Rate This governs how the loan will convert to shares at the conversion event. When a trigger event is a priced round, the conversion rate is the share price of the round less a discount. The conversion rate is generally the same as seen in a convertible note. However, unlike a convertible note, no interest will have accrued which needs to be converted.
Discount Convertible notes commonly include a discount to reward investors for investing in the business early and through a higher risk mechanism. If the investor’s discount is 15%, this means that they will receive 15% more shares for their investment than if they were participating in the round directly. A SAFE also commonly contains a discount.
Valuation Cap Some convertible notes will contain a valuation cap. This will set the maximum conversion price for the loan. An investor may wish to negotiate a cap so as to better control the equity stake that they are to receive. A SAFE may contain a valuation cap.
Term For circumstances in which the company does not reach the conversion event, the convertible note will have a maturity date. At this date, the startup will generally either have to repay the loan or it will automatically convert to equity at a rate predetermined by the convertible note. A SAFE does not have a term or maturity date. This means that if the conversion event does not occur, the investor will never receive equity. This also means there is no need to track or negotiate deadlines which generally add to the stress of a raise.

 

***

Startups most commonly use a convertible note or SAFE in a seed round or in bridge financing between rounds. As more startups familiarise themselves with these instruments, investors will become more willing to invest in this way. If you have any questions about raising capital and how best to structure your round, get in touch with our startup lawyers on 1300 544 755. 

Webinars

Construction Contract Essentials

Thursday 12 August | 11:00 - 11:45am

Online
Understand how construction contracts are drafted and how to protect your construction business.
Register Now

Startup 101: Understanding Cap Tables and ESOPs

Thursday 19 August | 11:00 - 11:45am

Online
Cap tables and employee share option plans are essential for fast-growing startups. Learn more with this free webinar.
Register Now

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

The majority of our clients are LVConnect members. By becoming a member, you can stay ahead of legal issues while staying on top of costs. From just $119 per week, get all your contracts sorted, trade marks registered and questions answered by experienced business lawyers.

Learn more about LVConnect

Need Legal Help? Get a Free Fixed-Fee Quote

If you would like to receive a free fixed-fee quote or get in touch with our team, fill out the form below.

  • 2020 Excellence in Technology & Innovation – Finalist – Australasian Law Awards 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice – Winner – Australasian Lawyer 2020 Employer of Choice Winner – Australasian Lawyer
  • 2021 Fastest Growing Law Firm - Financial Times APAC 500 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review 2020 AFR Fast 100 List - Australian Financial Review
  • 2021 Law Firm of the Year - Australasian Law Awards 2021 Law Firm of the Year - Australasian Law Awards
  • Most Innovative Law Firm - 2019 Australasian Lawyer 2019 Most Innovative Firm - Australasian Lawyer