In prior articles, we addressed structural differences, valuation mechanics, governance implications, and tax considerations. This article returns to the documents themselves.
SAFEs and convertible notes are often described as “simple.” The documents are shorter than full preferred stock financing packages. They close quickly. They are widely used.
Yet in transactions—particularly priced rounds and acquisitions—the friction frequently arises not from headline terms, but from definitions and clauses that received little attention at issuance.
This article examines drafting provisions that routinely create downstream complications.
1. Capitalization Definitions
Few provisions matter more than how “Company Capitalization” or “Fully Diluted Basis” is defined.
Valuation caps are applied against a defined capitalization denominator. That denominator may include:
- Outstanding common stock
- Preferred stock
- Option pools (granted and ungranted)
- Other SAFEs or convertible notes
- Warrants
Small drafting differences materially change conversion outcomes.
For example:
- Does the capitalization include the option pool expansion required by the next financing?
- Does it include other SAFEs converting simultaneously?
- Is the definition fixed at issuance or recalculated at conversion?
These definitions often determine whether dilution is borne primarily by founders or shared across holders.
The headline cap number is only half the analysis. The denominator is the other half.
2. Pre-Money vs. Post-Money SAFE Mechanics
Modern SAFE forms distinguish between pre-money and post-money valuation caps.
Under a pre-money SAFE structure, dilution from other SAFEs may fall disproportionately on founders.
Under a post-money SAFE structure, each SAFE holder’s ownership percentage is more predictable relative to their investment—but stacking multiple post-money SAFEs can significantly compress founder ownership before a priced round.
Companies frequently mix forms over time, especially if different templates are used.
Inconsistent mechanics complicate pro forma modeling and can generate confusion in later rounds when institutional investors request cap table reconciliation.
Drafting discipline requires consistency.
3. Most-Favored-Nation (MFN) Clauses
MFN provisions allow early investors to adopt more favorable economic terms offered to later investors.
While seemingly benign, MFNs can:
- Create cascading repricing obligations.
- Require retroactive adjustments.
- Introduce administrative complexity if multiple instruments include MFNs.
In practice, MFNs can slow subsequent closings, particularly when later investors negotiate improved caps or discounts.
Founders sometimes agree to broad MFNs without appreciating that each new issuance may trigger prior holder rights.
The scope of the MFN—what terms are covered and how long the right survives—should be narrowly tailored.
4. Maturity and Default Provisions (Convertible Notes)
Convertible notes introduce maturity risk.
Drafting issues often include:
- Short maturity periods misaligned with realistic fundraising timelines.
- Ambiguous default interest provisions.
- Inconsistent conversion triggers.
- Lack of clarity on mandatory versus optional conversion.
As maturity approaches, these provisions become leverage points.
Well-drafted notes align maturity with expected financing cadence and clearly define:
- What constitutes a qualified financing.
- Whether conversion is automatic or elective.
- Whether repayment is mandatory or negotiable.
Ambiguity benefits no one when time pressure arises.
5. Qualified Financing Definitions
The definition of “Qualified Financing” determines when automatic conversion occurs.
Common drafting variables include:
- Minimum financing threshold.
- Whether bridge financings count.
- Whether equity issued for non-cash consideration qualifies.
- Whether the financing must be led by institutional investors.
If the threshold is set too high, conversion may be delayed longer than anticipated. If too low, conversion may occur in a round not intended to reset capitalization.
Precision here prevents strategic disputes later.
6. Conversion Mechanics in Change-of-Control Transactions
Acquisition scenarios often expose drafting weaknesses.
Key questions include:
- Does the instrument convert into common stock or shadow preferred?
- Does the holder receive a return of capital alternative?
- Is the conversion price based on cap mechanics or sale price?
- Is there a defined payout formula?
Different SAFE templates treat liquidity events differently.
Convertible notes may allow:
- Repayment of principal and interest.
- Conversion at cap.
- Optional election between repayment and conversion.
Ambiguous liquidity provisions create negotiation friction in M&A transactions, particularly when buyers seek certainty around closing payments.
Clarity at issuance reduces dispute risk later.
7. Amendment Mechanics
Early-stage instruments are often issued to multiple investors over time.
When amendments become necessary—such as:
- Extending maturity.
- Adjusting valuation caps.
- Cleaning up for a Series A.
- Restructuring prior to acquisition—
The consent threshold matters.
If unanimous consent is required, a single small investor can delay restructuring.
If majority consent suffices, coordination becomes more manageable.
Amendment provisions should be drafted with realistic future cleanup scenarios in mind.
8. Side Letters and Informal Variations
Side letters introduce hidden complexity.
Over time, companies may grant:
- Information rights.
- Pro rata participation rights.
- Advisory roles.
- Consent rights on specific matters.
If these rights are not tracked carefully, they resurface in diligence.
Institutional investors and buyers routinely request:
- Copies of all side letters.
- Confirmation of investor rights.
- Disclosure of any special arrangements.
Inconsistent side agreements can complicate priced rounds and acquisition negotiations.
Centralized documentation discipline is essential.
9. Over-Reliance on Templates
Standard forms are helpful. They are not substitutes for analysis.
Templates:
- Do not model dilution.
- Do not account for company-specific capitalization.
- Do not anticipate acquisition timing.
- Do not align maturity with operational runway.
Companies often treat SAFEs and notes as administrative formalities. In practice, these instruments form the foundation of future capital structure.
Customizing key definitions and thresholds to the company’s actual growth plan is prudent.
Strategic Observations
Across transactions, recurring drafting problems include:
- Misaligned capitalization definitions.
- Overly broad MFN clauses.
- Unrealistic maturity dates.
- Ambiguous liquidity event provisions.
- Inconsistent SAFE forms.
- Poor tracking of side letters.
None of these issues prevent financing. They do, however, create friction in later rounds and exits.
The smoother Series A financings and acquisitions are those where early documentation anticipated future capital structure needs.
Closing Note
SAFEs and convertible notes are often described as bridges. In reality, they are structural components of the company’s capitalization history.
Attention to drafting detail at issuance reduces the need for renegotiation under pressure.
In the next article, we will examine Series A readiness—how early instruments are cleaned up, consolidated, and integrated into institutional financing structures.
Early simplicity should not come at the expense of future clarity.