Convertible Notes & SAFEs: The Hidden Dilution Trap
Written By Haley Kopp
Convertible Notes and SAFEs are incredibly popular for early-stage fundraising. They’re fast, simple, and avoid the complexity of pricing a round too early.
But they can also create a false sense of ownership for founders, because of how they’re treated on the cap table.
Why They’re “Invisible” (For Now)
Unlike shares of stock, SAFEs and Notes don’t usually appear on a cap table as equity until they convert. On paper, the founders might still look like they own 100% of the company. In reality, SAFEs and Notes represent promises to issue shares in the future, often on founder-unfriendly terms.
The Problem With Multiple Terms
Founders often raise several SAFEs or Notes over time. Each may have different valuation caps or discount rates. That means when conversion happens, some investors will receive more shares than others and the founders’ ownership will be diluted in unexpected ways.
Example:
SAFE A: $500k with an $8M valuation cap.
SAFE B: $500k with a $12M valuation cap.
Next round: $10M valuation.
When the SAFEs convert at the next priced equity round, the SAFE with the $8M cap will convert at a lower price per share than the $12M cap SAFE holders and equity round investors (who will both be issued stock at the same price per share). This means that those $8M cap SAFE holders will get more equity than the new investors and other SAFE holders. And the founders’ slice shrinks more than they may have anticipated.
Best Practices for Founders
To avoid surprises, founders should:
Track SAFEs/Notes as if they were already equity. Even if they’re not on the official cap table yet, model them in your ownership calculations.
Run scenarios. Ask: “If we raise the next round at $10M, $20M, or $30M, what does each SAFE/Note convert into?”
Avoid stacking too many terms. The more varied the instruments, the harder it is to predict dilution and the more leverage investors have. If you are issuing multiple SAFEs or Notes, try to issue them with the same valuation cap or discount to as many investors as you can.
Use tools (or advisors). Modern cap table software can model SAFE/Note conversions accurately, but even if you are not using software or tracking it yourself, a lawyer’s spreadsheet will help you see the impact before it’s too late.
Takeaway
Convertible Notes and SAFEs are not “free money.” They’re a deferred ownership transfer. If you don’t track and model them, you may discover (at the worst possible moment!) that you’ve given away far more of the company than you realized.
Lesson for founders: Treat SAFEs and Notes like equity from day one. Otherwise, your “100% ownership” may be more like 60% once the math catches up.
Haley Kopp is a corporate lawyer focused on representing start-ups and small companies in formations, venture capital, angel investor financings, mergers and acquisitions, and general corporate matters.
Haley's diverse experience gives her a practical approach to solving complex business issues, whether guiding companies through financing rounds or corporate transactions. Her office can be reached at (619) 512-3652.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
