One of your startups raised a new funding round—congrats! Now they’re giving you the option to convert your SAFE (Simple Agreement for Future Equity) into stock, either Common or Preferred. The question is: should you convert your SAFE into stock if given the option?
First off, whether you even have the option (and aren’t required to convert automatically) depends entirely on your SAFE agreement. Some SAFEs and Convertible Notes convert automatically at the next qualified financing round, while others may convert at the issuer’s discretion, and yet others give you, the investor, the choice to convert.
Before diving into the pros and cons from an investor’s perspective, it’s important to understand there’s a company (i.e. issuer) angle here too. Sometimes having a large number of SAFE-holders on the cap table can deter later-stage investors. So, companies may prefer that investors convert their SAFEs promptly into equity to simplify their cap tables, ensuring smoother future financing rounds. Thus, as an investor, you should also consider that your choice of whether to hold off on converting could indirectly hurt the company’s chances for follow-on financing or long-term success.
Pros of NOT Converting your SAFE
From the investor’s perspective, there aren’t many reasons you’d choose not to convert your SAFE—but there are some potential advantages:
- Potential to Reduce Dilution: By not converting your SAFE immediately, you might reduce your future dilution. You’re essentially betting that the company will raise another funding round later, allowing you to convert then instead. Since your SAFE’s conversion price is typically locked in based on valuation cap or discount, waiting means you’ll get that same (potentially more favorable) conversion price at a future round—after more capital has been raised—potentially resulting in less dilution.
- Waiting for More Favorable Stock Terms in a Future Round: Additionally, in rarer circumstances, an investor might delay conversion hoping for more favorable stock terms in a future round (a speculative bet), to avoid immediate administrative tasks, or due to specific personal tax/regulatory complexities (though these are usually outweighed by benefits like QSBS).
Cons of NOT Converting your SAFE to Stock
However, the cons of not converting your SAFE to stock at the first opportunity typically outweigh the potential benefits:
- Missing out on QSBS Tax Benefits: If you delay converting your SAFE, you don’t technically own “equity” yet. This means the 5-year clock for Qualified Small Business Stock (QSBS)—which can offer significant tax savings, sometimes up to 100% tax-free gains—doesn’t start until you convert your SAFE into actual stock.
- Limited Liquidity Options: Converting your SAFE often coincides with removing restrictions under Rule 144, making your shares potentially eligible for secondary market transactions. Without converting, you won’t have this liquidity option if or when a secondary market exists.
- Missing Potential Dividends: While dividends are uncommon in startups, if dividends are paid out, you won’t receive them if you’re holding a SAFE. Converting to stock ensures eligibility for dividends.
- No Voting Rights: Holding a SAFE means no voting rights. While voting isn’t common for crowdfunding investors, converting to stock could provide an opportunity—however small—to influence key company decisions.
- Liquidation Preferences and Rights: Depending on the type of stock your SAFE would convert into (usually Preferred or Common), your rights in the event of liquidation or a company sale could vary significantly. Stockholders often have clearer, more defined rights and protections.
Bottom Line
Many investors opt to convert their SAFE at the earliest opportunity, primarily due to QSBS benefits, liquidity options, and having clearer equity rights. However, each situation is unique, and there may be valid reasons for you personally not to convert immediately.
Always weigh these risks and trade-offs carefully before making your decision. If unsure, it’s wise to consult with a financial advisor familiar with SAFEs and equity investments.