Introduction
Early-stage startups often need capital before they can confidently determine a valuation. To address this challenge, founders and investors commonly use Convertible Notes or SAFE (Simple Agreement for Future Equity) agreements. Both instruments defer valuation until a future priced equity round; However, they differ materially in legal nature, risk allocation, investor rights, and regulatory treatment.
This blog explains how each instrument works, its practical advantages and drawbacks, India- and US-specific regulatory nuances, and concludes with a clear comparison table to help founders, CFOs, and investors make informed decisions.
What is a Convertible Note?
A Convertible Note is a debt instrument that converts into equity at a later stage, typically during a priced funding round. Until conversion, it operates like a loan owed by the company to the investor.
Key Characteristics
- Initially classified as debt.
- Carries an interest rate.
- Has a defined maturity date.
- Converts into equity using a valuation cap, discount, or both.
Understanding the Valuation Cap
A valuation cap sets the maximum valuation at which the investor’s money converts into equity in the next funding round. Its purpose is to reward early investors for assuming higher risk. Even if the company later raises funds at a significantly higher valuation, the convertible note holder converts as if the valuation were capped at the agreed level, resulting in a larger equity stake.
Convertible Notes in India – DPIIT Framework
In India, the use of convertible notes is specifically regulated. Only DPIIT-recognised startups are permitted to issue convertible notes. Without DPIIT recognition, issuing a convertible note is not allowed.
Key DPIIT Conditions
| Particular | Requirement |
|---|---|
| Eligible Entity | DPIIT-recognised startup |
| Minimum Investment | ₹25 lakh per investor (single tranche) |
| Instrument Type | Convertible debt |
| Maturity Period | Maximum 10 years |
| Extensions/Rollovers | Allowed only if total period ≤ 10 years (no regulatory relaxation beyond that) |
| Conversion | Equity shares or Compulsorily Convertible Preference Shares |
| Valuation | Determined at a future priced round |
| ROC filing – MGT-14 (for special resolution) | Required to be filed with ROC within 30 days of passing the special resolution |
What is a SAFE Agreement?
A SAFE (Simple Agreement for Future Equity) is not a loan. It represents a contractual right to receive equity in the future upon the occurrence of a defined triggering event, usually a priced funding round.
Originally designed to simplify early-stage fundraising, SAFEs remove many debt-related features found in convertible notes.
Key Characteristics
- Not classified as debt
- No interest obligation
- No maturity date
- Converts into equity in a future priced round
- Generally, founder-friendly and documentation-light
Common Types of SAFEs
- Valuation cap only
- Discount only
- Valuation cap plus discount
- MFN (Most Favoured Nation) SAFE
Practical Differences That Matter in Fundraising
Maturity Pressure
SAFEs do not have a maturity date, allowing founders to grow the business without the time-based pressure of raising a priced round. Convertible notes typically mature within 18–36 months. If no qualifying round occurs, investors may demand repayment or renegotiate terms, which can force founders into premature or suboptimal fundraising decisions.
Interest and Dilution Risk
SAFEs do not accrue interest. Dilution depends solely on valuation caps or discounts. Convertible notes accrue interest over time, which is added to the principal at conversion if not paid, increasing the investor’s equity stake and founder dilution.
Investor Leverage
Convertible notes provide investors with stronger downside protection due to their debt nature and maturity rights. SAFEs, in contrast, generally offer fewer enforcement rights prior to conversion, giving founders greater operational flexibility.
Convertible Notes vs SAFE – Comparison Table
| Feature | Convertible Note | SAFE Agreement |
|---|---|---|
| Legal Nature | Debt instrument | Contractual equity right |
| Interest | Yes | No |
| Maturity Date | Yes | No |
| Repayment Obligation | Yes (if not converted) | No |
| Conversion Trigger | Priced round or maturity | Priced round |
| Valuation Cap | Optional | Optional |
| Discount | Common | Common |
| Balance Sheet Impact | Recorded as a liability | Usually not a liability |
| Investor Protection | High | Moderate to low |
| Founder Friendliness | Moderate | High |
| Legal Complexity | Higher | Lower |
When to Use a SAFE vs a Convertible Note
SAFEs are generally suitable when:
- The startup is at a very early stage.
- Speed and simplicity are critical.
- Founders want to avoid debt and maturity pressure.
- Investors are comfortable with higher risk.
Convertible Notes are generally preferred when:
- The round size is relatively large.
- A priced round is expected in the near term.
- Investors seek stronger downside protection.
- Regulatory clarity around debt instruments is important.
India & US – Jurisdiction-Specific Nuances
India-Specific Considerations
Convertible Notes in India
- Permitted only for DPIIT-recognised startups.
- Issuance to non-residents is allowed under FEMA, subject to:
- Minimum investment threshold
- Time-bound conversion
- FEMA-compliant valuation at conversion
- Treated as debt under the Companies Act until conversion.
- Interest accrual, board approvals, and disclosures are mandatory.
- Cross-border notes may trigger withholding tax on interest.
SAFE Agreements in India
- SAFEs are not expressly recognised under the Companies Act or FEMA.
- Commonly implemented through SAFE-inspired contractual structures (iSAFE)
- Structured to result in the automatic issuance of CCPS upon a triggering event.
- FEMA pricing and sectoral norms
- If the investor is a foreign resident, iSAFE investments are subject to FEMA pricing norms and sectoral FDI limits applicable to inbound foreign investment.
While US SAFEs are not legally recognised in India, startups use SAFE-inspired contractual arrangements (commonly called iSAFE) that are structured to compulsorily issue of CCPS and comply with FEMA pricing and sectoral norms.
Practical Insight (India): Convertible notes provide clearer regulatory certainty, while SAFEs require careful structuring to remain compliant.
United States-Specific Considerations
Convertible Notes in the US
- Widely used and well understood.
- Treated as debt for tax and accounting purposes until conversion.
- Interest may be taxable to investors.
- Typically issued under private placement exemptions.
SAFE Agreements in the US
- Market standard for pre-seed and seed rounds.
- Treated as equity-linked instruments.
- No interest or repayment obligation.
- Subject to federal and state securities compliance.
- For aliens – Investment is generally permitted, but subject to US securities laws (Regulation D)
Why SAFE Is Not Legally Defined in India
SAFE was developed in the US startup ecosystem and does not have a defined legal status in India. It is not recognised as equity or debt under Indian law and is not expressly covered under the Companies Act or FEMA, creating regulatory ambiguity.
Evolution of iSAFE
To address this gap, Indian law firms, angel networks, and venture capital participants developed SAFE-like contractual structures underwhich CCPS are automatically issued upon a defined triggering event, in accordance with Indian regulations. This market-driven structure is commonly referred to as iSAFE.
What is iSAFE?
iSAFE is a contractual investment arrangement that:
- Is not a debt instrument
- Has no interest or maturity
- Structured to result in automatic issuance of CCPS upon a triggering event.
- Enables early-stage fundraising without immediate valuation fixation
Final Thoughts
Convertible Notes and SAFE agreements serve the same fundamental objective raising capital without fixing valuation upfront but they allocate risk and control very differently. The optimal choice depends on the startup’s stage, investor profile, jurisdiction, and long-term fundraising strategy.
Making the right decision early can prevent cap-table complexity, regulatory exposure, and governance challenges in future rounds.