Should I use vaults or convertible promissory notes for my startup's first investment round?

By Doug Bend, Founder of Bend Law Group, PC, a law firm focused on small businesses and startups.

Startups raising their first round of capital need to decide what type of investment vehicle to use.

The two most popular options are convertible promissory notes and SAFEs, or a simple future capital agreement.

Convertible promissory notes and SAFEs are similar in that the startup gets investment capital now in exchange for the investor's opportunity to convert their investment into equity if there is a trigger event , like a Series A ride, on the road. A key difference is that, unlike convertible promissory notes, SAFEs have no interest rate or maturity date.

Convertible promissory notes used to be more popular, but the growing trend is that most startups are using SAFEs instead, for four reasons.

1. No interest rate

Unlike convertible promissory notes, SAFEs do not include an interest rate.

Thus, startup founders have to give up less equity in their business by using SAFEs instead of convertible promissory notes with comparable valuation terms.

2. No due date

In addition, unlike convertible promissory notes, SAFEs have no maturity date.

The maturity date of convertible promissory notes is often 18 or 24 months. Startups that use SAFEs instead don't have an impending maturity deadline.

If a startup uses a convertible promissory note and the note has not been converted by the maturity date, investors have the power to negotiate better terms in exchange for an extension of the redemption date. deadline.

3. Speed ​​and simplicity

SAFE means a simple deal for future equity, which can lead to faster investment cycles that not only often cost less money in legal fees, but are also less likely to burn the relational capital of the founders with the investors.

For example, founders can send investors a red line indicating changes to SAFE models that have been open sourced by Y combinator. Experienced investors often look at these red lines, nod their heads and focus only on the valuation cap that is in the SAFE because they know that the other terms of the SAFE are market and fair.

This helps facilitate rapid fundraising, which not only takes less time for founders, but also decreases the risk of an investor losing interest in the investment. This feature is especially useful now that the investment landscape is rapidly changing.

4. Not a debt instrument

Unlike a convertible promissory note, a SAFE is not a debt instrument. This could make it easier for a startup to obtain traditional funding from banks, as there is less debt on the books with a SAFE compared to a convertible promissory note.

Of course, the reasons founders prefer SAFEs are the same reasons investors often prefer convertible promissory notes. Investors would prefer their investment to earn interest and have the ability to renegotiate the terms of the investment if the triggering event has not occurred by the maturity date. Additionally, investors might be more familiar and comfortable with convertible promissory notes because they have been in the startup ecosystem longer than SAFEs.

Long history as a lawyer, if you're a startup founder, you'll probably be better served using SAFEs. Whereas if you are an investor, you would probably prefer a convertible promissory note.

In all cases, founders should exercise caution and work with their attorney and accountant to ensure that the terms and amount of capital raised will not unduly dilute their ownership distribution in their business.< /p>

The information provided here does not constitute legal advice and is not intended to replace the advice of an attorney on any specific matter. For legal advice, you should consult an attorney regarding your specific situation.