Demystifying Startup Financing: What You Need to Know About SAFE, Convertible Note, and Equity

A lot of startups feel that if they just had money, everything would be better. While funding certainly provides fuel to growth and success, there are many other factors to consider when traveling the entrepreneurial journey. Excluding those other factors, it is important to understand the best structure for your funding efforts.

When it comes to financing a startup, there are a number of options available for structuring your deal, each with its own unique advantages and disadvantages. Three popular options are:

1. the Simple Agreement for Future Equity (SAFE), 
2. Convertible Note, and 
3. Equity. 

In this article, we will explore the differences between these three financing instruments and help startups determine which one may be the best fit for their specific needs.

SAFE

A SAFE, a Simple Agreement for Future Equity, is a type of security that allows startups to raise funds from investors without giving up equity in their company. The SAFE is essentially a contract between the startup and the investor, in which the investor provides funds to the startup in exchange for the right to receive equity in the future, typically tied to a trigger event, such as the next round of funding or acquisition. Unlike a Convertible Note, a SAFE does not have a maturity date or an interest rate. This can be attractive to investors who are betting on the startup's long-term potential, but may not be as attractive to investors who are looking for a more concrete timeline for their return on investment.

CONVERTIBLE NOTE

A Convertible Note is a debt instrument that can be converted into equity at a future date or when a certain trigger event occurs. Unlike a SAFE, a Convertible Note typically has a maturity date and an interest rate. This means that the investor is essentially lending money to the startup, with the expectation that the investment will eventually be converted into equity. A Convertible Note can be a good option for startups that are looking to raise funds quickly, as it is often faster and easier to set up than an equity round.

EQUITY

Equity is the most traditional form of financing for startups and involves the sale of ownership shares in the company. Equity rounds can take a variety of forms, such as preferred stock or common stock, and can be sold to both institutional and individual investors. Equity rounds are often used by startups that are further along in their development and are looking to raise larger sums of money.

So which financing instrument is the best option for your startup? As we have seen, the answer depends on a number of factors, including the stage of the startup, the amount of money being raised, and the preferences of the investors, which can often be impacted by their location.

If your startup is in the early stages of development and is looking to raise a smaller amount of money quickly, a SAFE may be a good option. The lack of a maturity date and interest rate can be attractive to investors who are betting on the startup's long-term potential. 

If your startup is further along in its development and is looking to raise a larger sum of money, a Convertible Note may be the best option. This debt instrument can provide a more concrete timeline for when the investor will receive their return on investment, and the interest rate can be attractive to investors who are looking for a guaranteed return. 

Finally, if your startup is further along in its development and is looking to raise a significant amount of money, an Equity round may be the best option. The sale of ownership shares can provide the startup with the capital it needs to grow and expand, while also giving investors a stake in the company's success.

Ultimately, each financing instrument has its own advantages and disadvantages, and the right choice will depend on a number of factors specific to the startup and the investors involved. It is important for startups to carefully consider their options and to work with legal and financial professionals to ensure that the terms of the financing instrument are fair and beneficial to all parties involved. By carefully considering their options, startups can find the financing solution that best meets their needs and helps them to achieve their long-term goals.