SAFEs are not bad for entrepreneurs
As somebody who has been on both sides of the investment table, I can confirm that very few founders understand the complexities of convertible notes (SAFE or otherwise). But I think the authors of both the pro and con argument are covering only one of the points. Yes, first time founders often don&#x27;t intuitively understand the impact of convertible notes on their cap table. But that&#x27;s not that hard to model. Much harder to understand are the secondary impacts of convertible notes. I have raised, led and participated in dozens of rounds and, frankly, still get caught out by those.<p>In general, the problem is that most benefits that investors enjoy are properties of their shares rather than the money that they invested. For an equity round this is one and the same. Not so much for convertible notes. A simple example:<p>An entrepreneur raised a $1M convertible note with a $5M cap. Ignore discount, interest and other factors for now. She then raises a $5M round at a valuation of $20M. That yields a dilution of 20% for the round plus a &quot;hidden&quot; dilution of ~17% for the note conversion (1&#x2F;6). That&#x27;s the blurry issue that both authors discuss. But if anything the share rights are even blurrier. Let&#x27;s say that the equity round came with what is commonly referred to as a 1x liquidation preference (non-participating). So they would get $5M back before other shareholders get anything. Even though I just worded that as matching the money that they put in, it is generally a property of the share class that the investors hold. For example, their $5M might have bought 5M shares at $1&#x2F;share that each says &quot;redeemable for $1 or convertible to common shares&quot;. Our note investors also hold those shares now. But instead holding one per dollar, they now hold four per dollar (since they pay 1&#x2F;4 the price for such a share). Suddenly, they have effectively a 4x liquidation preference benefit and the company has to return a full $9M before common shareholders&#x2F;founders see a penny of payout (despite only having $6M in the bank).<p>Interest rates, pre-round ESOP increases, and many other factors in convertible notes make this problem worse. And it affects just about all aspects of the cap table including voting rights, protective provisions, redemption rights, etc.. Basically, the bigger the gap between the cap and the eventual round, the bigger the privilege the note investors pick up. Not just in economic benefit where you would expect it, but also in power&#x2F;insurance&#x2F;protections&#x2F;etc. where it isn&#x27;t obvious at all. Nowhere in your term sheet for the note or equity round will it mention 4x liquidation preference. Doing so would cause instant rejection of the deal by even the most inexperienced founder! But that&#x27;s exactly would is going to happen once all the conversion mechanics are executed. And that can catch even seasoned entrepreneurs off guard (and seasoned investors, including plenty of note holders who never understood that they would get these benefits).<p>Convertible notes - SAFE or otherwise - have a role to play in venture financing. But they are complex instruments and should be use carefully. Anything else is just a recipe for pain in the long run.