A convertible promissory note is a debt obligation in which a company borrows money from an investor in exchange for a promise of repayment and an option to convert the outstanding principal into equity of the company upon some triggering event. Notes have a maturity date and bear interest. For earlier stage companies in particular, the negotiation of the terms is ideally limited. When parties avoid customization, notes are quick, fairly simple, and familiar to investors. That said, investors often require some customization, and companies must contend with resulting negotiations and variances in notes.
In a Safe, a company agrees to give an investor a future equity stake in the company if—and only if—certain trigger events occur. It is not a debt instrument; it does not have a maturity date, and it does not bear interest. It is also not an equity stake; unless and until a triggering event occurs, the investor is entitled to nothing. There are very few negotiated terms. Instead of customizing the agreement at all, the concept behind a Safe is that the parties can rely on industry-standard forms that are free and publicly available. Safes are designed to be quicker, simpler, and cheaper than notes, but they can be unfamiliar.
Assuming that the negotiation of the notes is minimal, the cost of development and implementation of the documents is comparable, although Safes are typically less expensive in that there should be truly minimal negotiation of the form, and no need to re-negotiate a maturity date, as there may be if a company reaches the maturity date of its notes and is not ready to repay or convert.
Companies may prefer a Safe because they find it more approachable and it puts more risk on the investor. Essentially, there is no need to repay if a triggering event does not occur. However, companies must be cautious at over using this tool, as it can complicate and quickly dilute capitalization.
On the other hand, investors may be resistant to the Safe. Investors are more familiar with notes, a historically more popular instrument for seed investments. There can be confusion over the impact of the Safe on the percentage of equity that the founders and the investors may eventually own, particularly when the Safe is based on a pre-money valuation, there are multiple rounds of Safes, or one or more of the parties insists on tweaking the terms. That said, over the last few years, the developers of the Safe have effectively evolved the forms, popularizing the instrument by making it more attractive to investors. For example, in a Safe containing a valuation cap, the cap is now keyed off of a post-money valuation of the company, giving the investor anti-dilution protection and more certainty around the amount of potential ownership than a Safe with a pre-money valuation cap. Still, investors may resist a Safe because they lose out on interest, cannot hold the company to a deadline, and have no guarantee of repayment or ownership, among other things. Companies may relieve an investor’s discomfort by offering a Safe with a discount (thereby giving the investor a good price on eventual equity) or including a most-favored nations clause (allowing the investor to take advantage of better terms that the company later offers to others).
While industry participants should consider their options carefully and select the best form of investment for the business in issue, the Safe has gained traction and popularity and can be a useful tool to swiftly fund a company prior to entering into a round of the more classic and fulsome convertible promissory notes.