DealLawyers.com Blog

A recent Nixon Peabody memo provides an overview for emerging companies of the differences between the use of convertible debt and simple agreement for future equity for early stage financings. This excerpt addresses which of the two financing vehicles may be the preferred alternative for a particular company:

Both notes and SAFEs delay the valuation discussion since there isn’t a valuation upon issuance of the note or SAFE (although valuation may loosely be discussed if a valuation cap is to be agreed to). Delaying agreement on a valuation may provide emerging companies with more flexibility to keep the exercise price for options (based on the fair market value of the underlying stock) low, thereby making options more valuable as a tool to better attract talent. In addition, both convertible notes and SAFEs typically don’t include a change to the board of directors beyond a significant holder being a board observer, and the holders will not be considered shareholders with voting or other shareholder rights.

Still, SAFEs offer a few additional advantages to the company relative to convertible notes. They do not accrue interest or have a maturity date, and because SAFEs are not debt, their holders are not creditors. SAFEs also benefit from having a few well-understood industry forms, which could help streamline negotiations over notes. As a result, in all cases, SAFEs are the preferred mechanism for companies. Of course, at the end of the day, the investor may insist on a convertible note, and a company’s preference for a SAFE is only as good as the SAFE’s ability to attract investors.

That last sentence is a pretty good summary of the “golden rule” that every emerging company should keep in mind when negotiating with potential investors – “those who have the gold make the rules.”

– John Jenkins