Early-stage fundraising rarely begins with a traditional priced equity round. Instead, most pre-seed and seed investments are structured using one of two instruments: SAFE notes (Simple Agreement for Future Equity) or convertible notes. Both allow startups to raise capital quickly without the cost and complexity of a full valuation negotiation — but they work differently, carry different risks, and are better suited to different situations. Understanding these instruments, along with the term sheets that govern later priced rounds, is essential knowledge for any founder raising capital.
This guide explains how each instrument works, when to use it, what to negotiate, and how they interact with your cap table — with specific attention to how European practice differs from the US.
What Is a SAFE Note?
A SAFE (Simple Agreement for Future Equity) is an investment contract created by Y Combinator in 2013 to simplify early-stage fundraising. It is not debt — there is no interest rate, no maturity date, and no repayment obligation. Instead, a SAFE gives the investor the right to receive equity in the company at a future date, typically when the company raises a priced round (such as a Series A).
The elegance of the SAFE is its simplicity. The standard Y Combinator SAFE is a five-page document with minimal negotiation points. There are no lawyers’ fees to negotiate complex terms, no board seats, and no ongoing governance obligations. For founders raising a quick pre-seed or seed round, a SAFE is the fastest path from handshake to wire transfer.
How SAFEs convert. When the company raises a subsequent priced round (the “qualifying financing”), the SAFE converts into equity — specifically, into the same class of shares issued in that round (typically Series A Preferred). The conversion price is determined by the terms negotiated in the SAFE, usually a valuation cap and/or a discount rate.
Valuation cap. The cap sets the maximum valuation at which the SAFE converts. If the SAFE has a €5 million cap and the Series A is priced at €15 million pre-money, the SAFE investor converts at €5 million — giving them significantly more shares per euro invested than the Series A investors. The cap protects early investors from excessive dilution if the company’s valuation increases substantially between the SAFE and the priced round.
Discount rate. Some SAFEs include a discount (typically 15-25%) applied to the price of the next round. If the Series A price per share is €10 and the SAFE has a 20% discount, the SAFE converts at €8 per share. Discounts can be used alone or in combination with a cap, in which case the investor gets whichever method produces the lower conversion price.
What Is a Convertible Note?
A convertible note is a short-term debt instrument that converts into equity at a future financing event. Unlike a SAFE, it is technically a loan — it carries an interest rate (typically 4-8% annually), has a maturity date (usually 18-24 months), and creates a legal obligation for the company to either repay the note or convert it to equity.
Convertible notes predate SAFEs by many years and remain widely used globally, particularly in Europe. The conversion mechanics are similar to SAFEs — the note converts at the next priced round, subject to a valuation cap and/or discount. However, the accrued interest on the note also converts, slightly increasing the investor’s ownership.
Maturity date implications. If the company has not raised a qualifying round by the maturity date, the note technically becomes due and payable. In practice, most founders and investors negotiate an extension rather than force repayment (which would likely bankrupt an early-stage startup). However, the maturity date gives investors leverage — and savvy investors use it to negotiate additional terms at extension.
Interest accrual. While the interest rates on convertible notes are modest (4-8%), the accrued interest converts to equity alongside the principal, slightly increasing the investor’s stake. On a €500,000 note at 6% over 18 months, the investor would convert €545,000 — not a dramatic difference, but it adds up across multiple notes.
SAFE vs Convertible Note: When to Use Each
The choice between a SAFE and a convertible note depends on jurisdiction, investor preferences, and the specific circumstances of the raise.
SAFEs are best suited for very early rounds (pre-seed and early seed) where speed is paramount and the investor base is primarily angels or seed funds familiar with the instrument. SAFEs are standard in the US, increasingly common in the UK and Nordics, and gaining traction across continental Europe. Their simplicity keeps legal costs low (often under €2,000) and allows founders to close individual investors independently over weeks, rather than needing to coordinate a single close.
Convertible notes are preferred in many European jurisdictions where the legal framework is better established for debt instruments. Germany, France, Switzerland, and the Benelux countries have well-developed convertible loan structures that local lawyers and investors understand deeply. France has its own variant — the BSA-AIR — which functions similarly to a SAFE but is adapted to French corporate law. Convertible notes are also preferred by investors who want the additional protection of a maturity date and interest accrual.
Practical considerations. If your investors are predominantly US-based or from the global angel/accelerator ecosystem, SAFEs are the path of least resistance. If your investors are European funds or local angels, ask what they typically use — forcing an unfamiliar instrument on investors slows the process and increases legal costs.
Key Terms to Negotiate
Whether using a SAFE or a convertible note, the most important terms to negotiate are the valuation cap and the discount rate. These determine how much of the company early investors will own when the instrument converts.
Setting the cap too low gives early investors an outsized stake and can create problems at Series A — incoming investors may demand the cap table be cleaned up, or may reduce their offer to compensate for the existing overhang. Setting the cap too high defeats the purpose of the instrument, as early investors receive little benefit for taking the highest risk.
A reasonable approach is to set the cap at a valuation you would be comfortable with as the pre-money valuation of a small seed round — typically €2 million to €6 million for European pre-seed/seed stage companies, depending on the sector and team strength.
Other terms to watch include pro-rata rights (the investor’s right to participate in future rounds to maintain their ownership percentage), most favoured nation (MFN) clauses (which ensure early investors get terms at least as good as later investors in the same round), and information rights (quarterly updates, financial statements).
Understanding Term Sheets for Priced Rounds
When a startup raises a Series A or later round, the investment is structured as a priced equity round governed by a term sheet. The term sheet is a non-binding document (with limited exceptions) that outlines the economic and governance terms of the investment. Once signed, it leads to binding definitive agreements (share purchase agreement, shareholders’ agreement, articles of association amendments).
Valuation and price per share. The pre-money valuation divided by the total shares outstanding gives the price per share. This determines how many shares the investor receives for their investment. European Series A valuations typically range from €10 million to €30 million pre-money, though AI and deeptech companies may command higher multiples.
Liquidation preferences. The standard in Europe is 1x non-participating preferred, meaning investors get their money back first in any exit (sale, IPO, or liquidation), then all shareholders share the remaining proceeds pro rata. Participating preferred — where investors get their money back AND share in the upside — is more investor-friendly and should be resisted by founders where possible.
Anti-dilution provisions. These protect investors if the company raises a future round at a lower valuation (a “down round”). Broad-based weighted average is the most common and fairest mechanism. Full ratchet anti-dilution is aggressive and can dramatically increase investor ownership at the expense of founders and employees.
Governance rights. Board composition, reserved matters (decisions requiring investor consent), and information rights are negotiated in the term sheet. Founders should pay close attention to the list of reserved matters — these can range from reasonable (approval of annual budget, major asset sales) to restrictive (consent for any hire above a certain salary, any contract above a certain value).
Common Pitfalls and How to Avoid Them
The most dangerous mistakes with early-stage instruments are those that create problems months or years later, often at Series A. Stacking too many SAFEs or convertible notes without tracking the cumulative dilution can lead to unpleasant surprises when they all convert simultaneously. A founder who has raised €1.5 million across six SAFEs may discover at Series A conversion that they have given away 40% of the company before the Series A investor even writes a cheque.
Inconsistent terms across multiple notes or SAFEs — different caps, different discounts, some with MFN clauses — create complex conversion scenarios that require careful modelling. Using a cap table tool like Carta, Ledgy (European-focused), or SeedLegals to track and model the conversion is strongly recommended.
Finally, founders should resist the temptation to raise too much on convertible instruments simply because it is easy. Every euro raised on a SAFE or note creates a future dilution event. If you need more than €2-3 million, consider structuring at least part of the round as a priced seed round — the additional cost and complexity are often worth the clarity it provides to all parties.