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Convertible notes
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SAFE agreements
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Here’s what else to consider
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1 Convertible notes
A convertible note is a debt instrument that can be converted into equity at a predetermined valuation or trigger event, such as a future funding round or an exit. The investor lends money to the startup and receives interest and a discount on the conversion price, which allows them to buy shares at a lower rate than the market value. The conversion price is usually based on a valuation cap, which sets a maximum valuation for the startup, or a valuation floor, which sets a minimum valuation.
Convertible notes have several advantages: they are simple and fast to negotiate and execute without needing a valuation or complex legal terms; they defer the valuation discussion until the startup has more traction and data; they provide flexibility and optionality for the investor; and they can attract more investors due to their lower risk and higher reward than equity. However, convertible notes also have some drawbacks: they create debt obligations for the startup, dilute the founder's ownership and control, create misalignment between investor and startup incentives, and complicate the cap table and funding rounds by introducing multiple classes of shareholders with different rights.
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2 SAFE agreements
A SAFE agreement, which stands for Simple Agreement for Future Equity, is a contract that grants the investor the right to receive equity in the startup at a future valuation or trigger event, similar to a convertible note. This type of agreement is not a debt instrument and does not accrue interest or have a maturity date. The investor pays a fixed amount of money to the startup and receives a discount or a valuation cap on the conversion price. There are several advantages to using SAFE agreements, such as being simpler and cheaper than convertible notes, not creating debt obligations or liabilities for the startup, and aligning the interests and goals of the investor and the startup. However, there are also some disadvantages to using SAFE agreements, such as being less familiar and accepted than convertible notes, diluting founder's ownership and control, creating uncertainty for the investor, and complicating the cap table and subsequent funding rounds.
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3 Here’s what else to consider
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