Convertible Securities
Convertible securities are financial instruments commonly used in startup financing that begin as debt or contract-based investments and convert into preferred stock upon a specified future event, such as a valuation cap or discount (i.e., shares are priced lower than for new investors at subsequent raises). They allow early-stage startups to delay valuation negotiations while raising initial capital.
There are two major types of convertible securities:
- Simple Agreement for Future Equity (SAFEs) are contractual agreements created by Y Combinator (the largest accelerator in the world) that provide the right to obtain equity in the future without being a loan or having a maturity date.
- SAFEs do not have an interest or a maturity date.
- Convertible notes are a short-term debt instrument that converts into equity in a future financing round.
- Since convertible notes are debt, they have an interest (usually per year) and a fixed maturity date ( months). If no conversion event occurs, the debt is due at maturity. Convertible notes work in favor of the investor, who is protected in case of downturn.