What are the differences among convertible notes, SAFEs, and equity financing?

Start-ups based in Silicon Valley typically use either convertible notes or SAFEs to raise initial capital and bridge themselves to their first equity financing round (and sometimes also between rounds). Both of these instruments are relatively simple to negotiate and enable companies to take in money quickly. They also represent a potential right to acquire equity ownership in the company from a corporate perspective but are not equity ownership themselves.

 The alternative to both of these is selling equity—generally selling either common stock or preferred stock.  Equity represents true ownership in the company, rather than a right to acquire ownership. Common stock, though simple to issue, is rarely used for venture investments. Investors usually want special control and financial rights with respect to the company that are easier to implement with preferred stock. In addition, the fair market value of the company’s common stock generally will be driven up by sales of that stock to third parties in an arm’s length transaction. Companies typically want to keep the value of their common stock lower in order to issue options with greater incentive potential to their employees and consultants. By selling a different type of stock to investors (i.e., preferred stock), companies are generally able to maintain a differential between the price that investors pay and the price at which they are able to offer common stock to their employees and consultants. For these reasons, most early-stage Silicon Valley companies scale by financing their operations by issuing equity in the form of preferred stock.

Below is a chart that compares all three securities:

	Convertible Note	SAFE	Preferred Stock
Is it debt or equity?	Debt	Unclear. From a tax perspective, it's typically viewed as equity. From a corporate perspective, it's not equity but rather a potential right to acquire equity	Equity
Does it set the company's valuation?	Possibly, depending on the terms	Unclear, but more so than convertible notes. It may impact the valuation from a tax perspective, but not from a corporate perspective	Yes
Does it have a maturity date?	Yes, typically between one and three years	No	No (Although it sometimes has redemption rights that serve as theoretical equivalents)
What happens on the maturity date?	The debt is techically supposed ot be repaid. Sometimes the investor is allowed to convert the note to common stock instead	Nothing (There is no maturity date)	Nothing (There is no maturity date)
Do investors who buy these securities get rights to exert influence over company decisions?	Not usually, but sometimes investors will negotiate for a few rights	No	Yes
Does the company have to pay dividends or interest to the investors?	Yes, the company pays interest	No	Usually not. While dividends are typically included as part of the terms of the stock, they generally only actually need to be paid if and when the board declares them, which early-stage companies do not do absent execptional circumstances
Does it dilute the current stockholders?	No, when issued Yes, when converted to equity No, if repaid in cash	No, when issues Yes, when converted to equity No, if repaid in cash	Yes

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