Raising a round and considering whether to do convertible or SAFE? Remember that convertible is debt that turns into equity based on certain parameters and SAFE is a specific type of convertible. This is an article about the pros and cons of each. But before starting, here are some previous posts that are relevant to this conversation:
2) Convertible Notes – 4 Practical Principles
3) SAFE: Great (Esp For Entrepreneurs), As Long As Done Safely
Caveat: different geographies have different norms, what is “typical” refers to the current standards in Silicon Valley.
1) Speed
In SAFE most terms are already agreed upon, the ones that are up for negotiation are discount and cap. The idea is decision-making be really quick and there be no legal fees, at least around the financing. Traditionally the discount has been 15-20% and cap 4-5x the amount being raised. Between Mar 2020 and Mar 2022 at Tau we have seen increasingly more deals where the discount was down to more like 10-15% and the ratio of cap / amount being raised has grown to 6-8x. It’s mostly a function of market conditions which have been changing significantly as we speak, so our expectation is we are going to see more of the previous norms
2) Further Fundraise
SAFE allows the entrepreneur to continue raising on the same terms, technically indefinitely. This is not necessarily always a good thing – the entrepreneur might delay the next round by too much and get overly diluted when the SAFE does convert. It’s also risky for an investor who has much less certainty around how much capital the startup will take and when they will convert.
3) Stage
Historically all rounds were priced, with convertibles becoming more popular in the early 2000s. The thinking was that in the very early stages things are very undefined and it’s better to not fixate on a particular ownership or valuation too early. For many years convertibles became synonymous with seed stage, and gradually started to show up in between formal rounds. SAFEs have followed a similar pattern especially since the 2010s, as well as with the institutionalization of pre-seed especially in the 2020s. Our experience is SAFE is indeed replacing convertibles across all stages.
4) Interest Rate
The specific case of SAFE aside, convertibles in general have interest rate and maturation date. 5% per year over 18 months is fairly common. Our view at Tau is interest rate doesn’t matter as much. If a startup does well then they will raise before this time period anyways and you will get converted. If it doesn’t then essentially you get your loan back plus a bit more, but chances are you could have lent that same money for a much higher interest rate in a less risky endeavor.
5) Investors In The Round
At Tau, as entrepreneurs/operators turned investors, we are strong advocates of bringing in not just capital, but smart capital. If the choice between a convertible or SAFE results in a better investor it should weigh heavily on what an entrepreneur chooses. These days SAFEs follow a binary distribution, attracting investors who are either new to investing or very sophisticated and comfortable with lower certainty. Also, large funds are typically more passive in a convertible or a SAFE because their expectation is to commit further when there is a priced round.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.
