Convertible loan and SAFE: tools for the pre-seed
At the very first capital stage — the pre-seed — it often makes no sense to fix a precise valuation straight away: the company is too young and any figure would be arbitrary. That is why tools exist that postpone the valuation to the next round, allowing capital to be raised quickly and lightly: the convertible loan and the SAFE. Let us see how they work and when to use them.
The problem they solve
A classic round with the issue of shares requires agreeing a valuation, drafting the documentation and amending the corporate structure. It is long and costly. In the pre-seed, when modest amounts and speed are needed, convertible instruments allow you to take the capital today and turn it into shares tomorrow, at the real round, when a valuation will make more sense.
The convertible loan
The convertible loan is, legally, a loan: the investor lends money to the company. The special feature is that, instead of being repaid in cash, the loan converts into shares upon the occurrence of an event, typically the next financing round.
Typical elements:
- Interest: being a loan, it often accrues interest, which is usually not paid in cash but added to the amount that converts.
- Maturity: a date by which, if the round has not taken place, the consequences must be defined (conversion, repayment, extension).
- Conversion: at the round, the loan becomes shares, as a rule on favourable terms compared with the new investors.
Being debt, it must be managed carefully, also from an accounting standpoint and with regard to the company’s balance-sheet equilibrium.
The SAFE
The SAFE (Simple Agreement for Future Equity) was created as a leaner alternative: it is not a loan, but an agreement granting the right to receive shares in the future, generally at the next round. It has no interest and, typically, no maturity: it is designed to be simple and fast.
It should be said that the SAFE originates in a legal context different from the Swiss one. In Switzerland it can be used, but it must be adapted to the legal form and to local law: its qualification and effects must be checked case by case, without taking for granted that it works identically to the original.
Cap and discount: the two key parameters
Both instruments reward those who enter early. Two recurring mechanisms:
- Discount: at the moment of conversion, the investor obtains shares at a price discounted relative to the new entrants of the round.
- Valuation cap: a ceiling on the valuation at which conversion takes place. If at the round the valuation is higher than the cap, the investor converts at the cap anyway, obtaining more shares. It is the way to reward those who took the risk when the company was worth less.
An agreement may provide for the discount only, the cap only, or both (as a rule the one more favourable to the investor applies).
Convertible loan or SAFE: how to choose
There is no single answer. In short:
- the convertible loan gives the investor more protection (it is debt, it has interest and a maturity) and is more established in European practice;
- the SAFE is simpler and faster, but requires careful adaptation to the Swiss context.
The choice depends on the amounts, the parties’ expectations and how the company is set up.
Watch out for dilution
Convertible instruments are not “free”: they convert at the next round and dilute the founders. If you issue several of them, with different caps and discounts, the combined effect at the round can be surprising. Always simulate the conversion on the cap table in advance, so you know where it will take you.
How we help you
At SIH ONE we structure pre-seed capital with the right instrument for your situation: the choice between convertible and SAFE, the definition of cap, discount and maturity, adaptation to Swiss law and coordination with the cap table and future rounds. Raising capital quickly is only useful if it does not create problems later.
Are you preparing a pre-seed? Talk to the Capital division.