In Article 1, we addressed structural differences between SAFEs and convertible notes. In Article 2, we examined valuation caps and discounts and how they drive dilution.
This article turns to a less discussed—but frequently more consequential—issue: how SAFEs and convertible notes affect control, governance dynamics, and transaction outcomes, particularly in scenarios where a traditional priced round never occurs.
Early-stage instruments are often described as “non-control” securities. Technically, that is accurate at issuance. In practice, their presence can influence board composition, negotiation leverage, acquisition terms, and recapitalization structures in ways that are not obvious at the outset.
The Illusion of Non-Control
SAFEs and convertible notes typically do not carry:
- Voting rights
- Board seats
- Protective provisions
- Information rights (beyond what is contractually specified)
Founders often view this as preserving control. And in the immediate term, it does.
However, control in venture-backed companies is not determined solely by formal voting rights. It is shaped by:
- Capital structure
- Conversion mechanics
- Liquidation preferences
- Timing of liquidity events
- The number and alignment of early investors
An instrument that lacks voting rights today may materially affect governance once it converts.
Conversion and Board Dynamics
When a priced round occurs, SAFEs and notes convert—usually into preferred stock alongside new institutional investors.
At that moment:
- Early investors become equity holders.
- Their ownership percentages are crystallized.
- The fully diluted cap table determines voting power.
- Board composition may be renegotiated.
If early instruments represent a significant portion of the capitalization, founders may enter the Series A already substantially diluted. That dilution influences board allocation, voting thresholds, and protective provisions demanded by new investors.
In some transactions, new investors condition their investment on cleaning up or restructuring outstanding instruments. This can involve amendments, side letters, or renegotiated conversion terms.
What appeared to be a passive instrument can become a focal point of governance negotiation.
When No Priced Round Occurs
The more complicated scenario arises when a company does not complete a traditional equity financing.
Three outcomes commonly arise:
- Strategic Sale Before a Priced Round
- Recapitalization or Down Round
- Wind-Down or Asset Sale
Each scenario reveals differences between SAFEs and notes.
1. Acquisition Before Conversion
In a sale prior to a priced financing, conversion mechanics become central.
Depending on the instrument:
- A SAFE holder may have the right to receive the greater of (i) a return of the purchase amount or (ii) conversion into common stock based on the valuation cap.
- A noteholder may have the right to repayment of principal plus interest or conversion into equity.
These options can materially affect purchase price allocation and negotiations with buyers.
For example:
- If SAFEs convert into a shadow preferred class with liquidation preference, they may dilute common holders more significantly.
- If noteholders demand repayment as creditors, closing mechanics may require debt payoff before distributing proceeds.
Buyers and their counsel scrutinize these mechanics closely. Instruments drafted casually in early rounds often resurface in diligence with unexpected consequences.
2. Down Rounds and Recapitalizations
If the next financing occurs at a lower valuation than anticipated, early instruments can create friction.
In a down round:
- Conversion at prior caps may create disproportionate dilution.
- Later investors may resist conversion terms they perceive as overly favorable to early investors.
- Amendments may require consent from holders who were previously passive.
Convertible notes approaching maturity add additional pressure. Investors may leverage maturity rights to negotiate revised caps or board protections.
SAFEs, lacking maturity, provide less formal leverage—but large SAFE holders may still exert influence through informal alignment or strategic voting after conversion.
Recapitalizations frequently require aligning multiple early holders with differing economic positions.
3. Insolvency and Liquidation
In a downside scenario:
- Convertible noteholders typically stand in the creditor class.
- SAFE holders usually sit between creditors and common equity, depending on form.
- Common shareholders absorb residual risk.
The practical impact depends on asset value at liquidation.
In asset-light startups, creditor claims may exhaust proceeds entirely. In other cases, SAFE holders may recover some portion of capital before common equity receives anything.
These priority mechanics shape investor risk allocation. They also influence how distressed sale negotiations unfold.
Investor Alignment and Fragmentation
Another overlooked governance issue is investor concentration.
When SAFEs are issued broadly across many small investors:
- Cap tables become fragmented.
- Obtaining consents for amendments or waivers becomes more complex.
- Coordinating responses during a sale can delay closing.
Convertible notes issued to a smaller group of institutional investors may consolidate leverage in fewer hands.
Neither outcome is inherently preferable. But founders should recognize that a highly distributed SAFE round may complicate future corporate actions.
Some companies address this through side letters or voting agreements at the time of conversion. Others wait until a priced round to consolidate holders under preferred stock governance documents.
Anticipating this dynamic early reduces friction later.
The Interaction with Protective Provisions
When SAFEs or notes convert into preferred stock, holders often enter into:
- Investor rights agreements
- Voting agreements
- Right of first refusal and co-sale agreements
At that stage, early investors acquire formal governance rights consistent with other preferred holders.
The percentage ownership resulting from conversion directly influences:
- Voting thresholds
- Protective provision approvals
- Drag-along mechanics
- Consent requirements for future financings or sales
Thus, the economics established at the SAFE or note stage ultimately influence formal governance architecture.
Dilution is not only economic. It is structural.
Control in the Absence of Formal Rights
Even before conversion, early investors can exert influence through:
- Follow-on investment expectations
- Informal advisory roles
- Strategic relationships
- Signaling to future investors
A company heavily dependent on one early noteholder may find that investor influencing strategic decisions, even absent voting rights.
Legal control and practical influence are distinct.
Founders should consider investor concentration and alignment as carefully as valuation terms.
Practical Observations from Transactions
Across transactions, several patterns recur:
- Early instruments drafted without modeling become obstacles in acquisition negotiations.
- Excessive SAFE layering reduces founder flexibility in later governance negotiations.
- Convertible note maturity dates often prompt renegotiations at inopportune times.
- Buyers request payoff letters, conversion confirmations, and capitalization reconciliations that require reconstructing years of early issuances.
The smoother transactions are those where early instruments were issued with forward planning in mind.
Strategic Discipline
Before issuing SAFEs or convertible notes, companies should consider:
- How will these instruments convert in a sale before a priced round?
- What governance rights will holders receive upon conversion?
- How many separate investors will need to consent to amendments?
- What does the cap table look like in a downside scenario?
- Are maturity dates aligned with realistic fundraising timelines?
These questions do not slow financing. They prevent friction later.
Looking Ahead
This article has focused on governance and exit dynamics—how SAFEs and convertible notes influence control, even when they appear passive.
In Article 4, we will examine drafting discipline and documentation pitfalls: common provisions that receive insufficient attention, including capitalization definitions, most-favored-nation clauses, and amendment mechanics.
Early-stage instruments are often treated as temporary. In practice, they shape the company’s capital structure for years.
Understanding their governance implications is as important as understanding their economics.