Founders usually hold common stock while outside investors buy preferred stock with different voting and economic rights, including liquidation preferences. SAFEs and convertible notes defer the valuation question and convert into preferred stock at the next priced round, usually at the lower of a valuation-cap price or a discounted price; a note is debt with interest and a maturity date, while a SAFE is not. Venture debt is a short-term, usually secured loan to venture-backed companies, typically with warrants and covenants, that is repaid rather than converted.
In this lesson you will
- Distinguish common stock from preferred stock and explain liquidation preference.
- Explain how a post-money SAFE converts and how its valuation cap, discount and MFN versions work.
- Describe the interest, maturity, cap and discount terms of a convertible note.
- Describe venture debt's typical structure and how it differs from convertible instruments.
Common and preferred stock
Stock represents an ownership interest in a corporation; common stock is more commonly issued to founders and preferred stock to outside investors, and the classes carry different voting and economic rights [1]. One of the most important economic rights is liquidation preference: if a company winds down and sells its assets, proceeds go to pay obligations and the remainder returns to shareholders in order of liquidation preference [6]. An LLC uses membership interests rather than shares, but it can create similar classes with different rights [1]. A priced round, in which a lead investor sets a valuation and buys preferred stock with full rights, often including a board seat, is typical from Series A onward [3].
SAFEs
A simple agreement for future equity (SAFE) is a contract in which the company promises the investor future equity if a triggering event occurs, such as an equity financing or an acquisition; until then the holder has no ownership interest [1]. Y Combinator created the SAFE in 2013 and has used the post-money SAFE as its standard since 2018 [2]. YC describes the SAFE as neither debt nor a loan: it has no interest and no maturity date [2]. It converts automatically into preferred stock when the company sells preferred stock in an equity financing, and the post-money SAFE has no minimum raise needed to trigger conversion [2].
- Valuation cap: the highest valuation at which the SAFE converts; if the priced round is above the cap, the SAFE converts at the cap [2].
- Ownership math: on a post-money cap SAFE, ownership sold equals the investment divided by the cap, so $1 million on a $6.7 million cap is about 15% [2].
- Discount: conversion at a price below the round price; YC says discounts are commonly 10–20% [2].
- MFN: no cap or discount, but it adopts the best terms of any SAFE issued later [2].
On an acquisition or IPO, a valuation-cap SAFE holder receives the greater of their money back or the as-converted amount; on a dissolution, they receive their purchase amount back, and in both cases the SAFE ranks behind debt and like non-participating preferred stock [2]. Post-money caps are additive, so YC warns that five $100,000 SAFEs at a $5 million cap sell 10% of the company, not 2% [3].
Convertible notes
A convertible note is a loan from an investor that can convert into a different security, often used at seed because early companies are hard to value; it typically converts automatically into preferred stock at the next funding round [1]. Because it is debt, interest accrues and the note has a maturity date by which it must be repaid or otherwise addressed [2][4]. YC's comparison puts typical interest at about 2–8% and notes that debt sits ahead of equity, including SAFEs, if the company is sold or wound down [3].
Beyond maturity, the key note terms are the valuation cap, discount rate and interest rate [4]. The cap sets the maximum company value at which the note converts; the discount lets the holder buy at a price below what new investors pay, which protects the holder if the round is priced below the cap; and accrued interest is typically added to principal, increasing the shares issued at conversion [4]. When a note carries both a cap and a discount, the conversion clause decides how they interact, so model both prices and read the clause rather than assuming.
Venture debt
Venture debt is non-dilutive financing in the form of term loans or lines of credit for venture-backed companies that have limited assets and are not yet cash-flow positive [5]. Terms are typically 12 to 48 months, because the loan is meant to bridge to the next equity round [5]. The loan is typically secured by company assets, and lenders typically receive warrants to buy shares later, alongside positive and negative covenants such as limits on additional debt [5]. Many venture lenders prefer companies with monthly recurring revenue [5]. Unlike a SAFE or note, venture debt is repaid; the lender's equity upside comes from the warrants, not from conversion of the principal.
Key terms
- Preferred stock
- A class of stock, usually sold to outside investors, with rights such as liquidation preference that common stock lacks.
- Liquidation preference
- The order and amount in which holders are paid when a company is sold or wound down.
- SAFE
- A simple agreement for future equity: a contract for shares issued later, with no interest or maturity date.
- Valuation cap
- The maximum valuation at which a SAFE or note converts into equity.
- Discount rate
- A percentage reduction from the next round's price at which a convertible instrument converts.
- MFN provision
- A 'most favored nation' term that lets an earlier holder adopt better terms given to later investors.
- Maturity date
- The date by which a convertible note must be repaid or otherwise resolved.
- Warrant
- A right to buy shares at a set price later; commonly granted to venture lenders.
Check your understanding
Sources
- [1]U.S. Securities and Exchange Commission, Capital-Raising Building Blocks, “Common Startup Securities,” June 12, 2024 (last reviewed August 8, 2025).
- [2]Y Combinator, “The SAFE — the open standard for startup fundraising,” Accessed November 2026.
- [3]Y Combinator, “SAFE vs. Convertible note vs. Priced Equity Round,” Accessed November 2026.
- [4]Shulman Rogers (via Legal 500), “What Is A Convertible Note?,” March 2, 2022.
- [5]American Bar Association, Business Law Today, “How Can Venture Debt Fuel a Start-up or Emerging Growth Company's Growth?,” March 11, 2020.
- [6]U.S. Securities and Exchange Commission, Capital-Raising Building Blocks, “Exit Strategies and Liquidity,” June 12, 2024 (last reviewed April 24, 2026).
Educational content only — not legal, tax, or investment advice, or an offer to sell or a solicitation of an offer to buy any security. Rules and data are described as of November 2026 and may change. Securities offered through Umergence LLC, Member FINRA/SIPC.