How SAFE Notes Work: Caps, Discounts, and Conversion
A SAFE, or simple agreement for future equity, is a contract in which an investor pays now for the right to receive shares later, usually at the company's next priced equity round. It is not debt: there is no interest or maturity date. A valuation cap, a discount, or both determine the price at which the investment converts into shares.
What a SAFE is
Y Combinator introduced the SAFE in 2013 as a simpler alternative to convertible notes for early investment, and released the post-money version in 2018, which has become the widely used standard.
The investor gives the company money today. In return, the investor receives a contractual right to shares when a defined future event happens. Until then, the investor holds no shares, has no voting rights as a shareholder, and is not a creditor.
That design is why SAFEs are fast and cheap to issue. There is no valuation negotiation beyond the cap or discount, no board seat, and no need to set a share price. The trade-off is that the eventual ownership depends on future events, which is why founders need to model conversion before signing.
What a SAFE is not. It is not a loan. There is no interest, no repayment date, and no default if the company never raises again. It is also not common stock, so it does not start any holding period for tax purposes until it converts.
When and how it converts
A SAFE typically addresses three events.
Equity financing. When the company sells preferred stock in a priced round, the SAFE converts into shares of that preferred stock, or a closely matching series, at the conversion price.
Liquidity event. If the company is acquired or goes public before a priced round, the investor generally receives the greater of their original investment back or the amount they would receive by converting at the cap.
Dissolution. If the company winds down, SAFE holders are typically entitled to their investment back from remaining assets, ahead of common stockholders and after creditors.
The conversion price.
- With a valuation cap, the price per share is the cap divided by the company's capitalisation as defined in the SAFE. If the priced round values the company above the cap, the SAFE investor converts at the lower capped price and receives more shares.
- With a discount, the price is the priced round's share price reduced by the discount percentage.
- With both, the investor receives whichever produces the lower price.
A worked example. An investor puts in 500,000 on a post-money SAFE with a 5,000,000 cap. Just before the priced round, that investor's ownership is 500,000 divided by 5,000,000, or 10 percent of the company including all SAFEs. The new round's investors then dilute everyone, including that 10 percent.
Why post-money matters
In a post-money SAFE, the cap represents the company's valuation including all SAFE money. Each investor can calculate their percentage at signing, and each additional SAFE dilutes the founders rather than earlier SAFE holders. Founders who issue several SAFEs need to add them up, because the combined dilution lands entirely on the existing common holders.
Side terms and practical points
Most favoured nation. An MFN provision lets the SAFE holder adopt better terms given to later SAFE investors before the priced round. Standard post-money forms include a version with MFN and no cap or discount.
Pro rata rights. Often granted in a separate side letter, letting the investor buy more shares in the next priced round to maintain ownership. These can reduce allocation available to new lead investors.
Information rights. Some investors request financial updates. SAFEs themselves usually do not include them.
Modified terms. Changes to standard forms, such as unusual definitions of company capitalisation, can shift the conversion math. Compare any SAFE against the standard form it claims to follow.
Record keeping. SAFEs belong on the cap table model even though they are not yet shares. Track each one's amount, cap, discount, MFN, and side letters, and model conversion at plausible round valuations.
Securities law. SAFEs are securities. Issuing them requires an exemption, commonly Regulation D in the United States, and state notice filings may apply.
Tax. The tax treatment of SAFEs for investors is not fully settled, and holding periods for capital gains purposes generally do not begin until conversion. Investors and companies should take tax advice.
This page is general information, not legal, tax, or investment advice. Terms and rules vary by jurisdiction and deal; get advice from counsel on a specific decision.
This is general information, not legal advice, and reading it does not create an attorney-client relationship. Talk to a qualified attorney about your specific situation.
Frequently asked questions
- How does a SAFE note work?
- An investor pays a startup now in exchange for the right to receive shares later, usually when the company raises a priced equity round. A valuation cap, a discount, or both set the conversion price. If the company is acquired or dissolves first, the SAFE's liquidity and dissolution terms apply instead.
- Is a SAFE debt?
- No. A SAFE has no interest rate, no maturity date, and no repayment obligation, so the company cannot default on it. That distinguishes it from a convertible note. SAFE holders are also not shareholders until conversion, so they have no shareholder voting rights before then.
- What is a valuation cap on a SAFE?
- A cap sets the maximum valuation used to calculate the SAFE's conversion price. If the priced round values the company above the cap, the SAFE converts at the lower capped price, giving the investor more shares than new investors receive for the same amount.
- What is the difference between a pre-money and post-money SAFE?
- In a post-money SAFE, the cap includes all SAFE money raised, so each investor knows their ownership percentage at signing and additional SAFEs dilute founders rather than earlier SAFE holders. In the older pre-money version, ownership depended on how much other SAFE money was raised.