Convertible Loan Notes or SAFE Agreements: Which Should Startups Choose?
When a startup raises external capital, a traditional equity financing round is not always the most practical solution. At an early stage, agreeing on the company’s valuation can be difficult, particularly where the business has limited trading history or is still refining its commercial model. At the same time, both founders and investors are often keen to complete the investment efficiently and without unnecessary cost.
Two of the most widely used alternatives are Convertible Loan Notes (CLNs) and SAFE agreements (Simple Agreements for Future Equity). Both instruments are designed to defer the valuation discussion until a later funding round, allowing the company to raise capital without immediately agreeing its worth.
Although they serve a similar commercial purpose, they differ significantly in both their legal structure and their commercial implications. Understanding those differences is essential before deciding which approach is most appropriate.
Why Delay the Valuation?
One of the greatest challenges facing early-stage companies is valuation.
Founders naturally believe in the long-term potential of their business, while investors are investing in a company that may still be pre-revenue or operating without an established market position. Any valuation agreed at this stage is therefore often based more on expectations than objective financial data.
Negotiating that valuation can delay fundraising and, in some cases, prevent an investment altogether.
Convertible instruments seek to avoid this problem by postponing the valuation until the company has reached a more mature stage. Rather than debating today’s uncertain valuation, the parties agree that the investor’s capital will convert into shares during a future investment round, when the market has provided a clearer indication of the company’s value.
For many startups, this approach allows management to concentrate on growing the business instead of becoming tied up in lengthy valuation negotiations.
What Is a Convertible Loan Note?
A Convertible Loan Note (CLN) is fundamentally a loan made to the company that may later be converted into shares.
Until conversion occurs, the investor is a creditor rather than a shareholder. The company owes repayment of the loan in accordance with the terms of the agreement unless conversion takes place.
The loan documentation typically deals with matters such as the principal amount, interest (where applicable), maturity date, conversion mechanics, valuation caps and discounts that reward investors for assuming greater early-stage risk.
When the company completes a qualifying funding round, the outstanding loan usually converts automatically into equity based on the agreed commercial terms.
Convertible Loan Notes have long been recognised within Swedish company law and remain one of the most commonly used financing instruments for Swedish startups seeking early-stage investment.
What Is a SAFE Agreement?
A SAFE (Simple Agreement for Future Equity) takes a different legal approach.
Unlike a Convertible Loan Note, a SAFE is not a loan. The investor provides capital to the company in exchange for a contractual right to receive shares if specified future events occur.
Because there is no loan, there is generally:
- no interest;
- no maturity date; and
- no obligation on the company to repay the investment in cash.
Instead, the investment remains outstanding until a future financing event triggers the issue of shares.
SAFE agreements were originally developed by Y Combinator and have become one of the standard financing instruments within the US startup ecosystem. While they are increasingly recognised internationally, they remain considerably less common in Sweden than Convertible Loan Notes.
The Most Significant Legal Difference
Although Convertible Loan Notes and SAFEs often achieve similar commercial outcomes, they place investors in fundamentally different legal positions.
A holder of a Convertible Loan Note remains a creditor until conversion occurs. The investor therefore has a debt claim against the company.
If the company becomes insolvent before conversion, creditors generally rank ahead of shareholders when company assets are distributed. Subject to the terms of the particular instrument, this may provide the investor with a stronger legal position than someone who already holds equity.
A SAFE investor occupies a different position.
Because a SAFE does not create a loan, the investor does not become a creditor. Instead, they hold only a contractual right to receive shares if the agreed conversion event takes place.
If the company fails before any conversion occurs, the practical consequences for the SAFE investor may therefore be significantly different.
This distinction is one of the principal reasons why many Swedish investors continue to favour Convertible Loan Notes over SAFEs.
Why Many Investors Prefer Convertible Loan Notes
Professional investors are generally concerned not only with the potential upside of an investment but also with managing downside risk.
A Convertible Loan Note provides a more familiar legal framework and offers the investor creditor status until conversion takes place. While that protection is not absolute, it often provides greater comfort than a purely contractual right to receive shares at some future date.
Convertible Loan Notes are also supported by an established statutory framework under Swedish company law, making them well understood by investors, legal advisers, auditors and boards of directors.
This degree of legal certainty is one reason why they continue to dominate early-stage fundraising in Sweden.
Why Startups Sometimes Prefer SAFEs
Despite the stronger legal framework associated with Convertible Loan Notes, SAFE agreements offer several practical advantages.
The documentation is often considerably shorter.
There are fewer corporate formalities.
Negotiations may be completed more quickly.
For startups raising relatively modest amounts of capital, these efficiencies can make a meaningful difference.
The simplicity of a SAFE is one of the reasons why it has become such a popular instrument among US technology companies, particularly during seed financing rounds involving multiple investors.
However, that simplicity also means that certain legal protections commonly found in Convertible Loan Notes may be absent or require bespoke drafting.
For Swedish companies, additional consideration must also be given to how a SAFE interacts with Swedish corporate law, shareholders’ agreements and future investment documentation.
Commercial Terms Still Matter
Whichever instrument is chosen, the legal structure represents only part of the overall transaction.
The commercial terms often have an even greater influence on the ultimate outcome.
Matters such as valuation caps, conversion discounts, qualifying financing thresholds, investor protections and treatment upon an exit transaction can significantly affect both founders and investors.
Two Convertible Loan Notes may appear similar while producing very different outcomes once conversion eventually takes place.
Likewise, two SAFE agreements may allocate economic risk in entirely different ways despite sharing the same overall structure.
For that reason, founders should focus not only on the type of instrument but also on the commercial provisions contained within it.
Which Instrument Is More Suitable?
There is rarely a universally correct answer.
For many Swedish startups raising capital from domestic investors, a Convertible Loan Note will often be the more familiar and practical solution. It benefits from an established legal framework and generally provides greater certainty for all parties involved.
SAFE agreements may be more appropriate where international investors are participating, where US market practice is expected, or where speed and simplicity are the primary commercial objectives.
Ultimately, the appropriate structure depends on the company’s stage of development, the expectations of its investors, the proposed funding strategy and the legal implications of each instrument.
Conclusion
Convertible Loan Notes and SAFE agreements both seek to solve the same commercial challenge: enabling startups to raise capital before a reliable valuation can be established.
They achieve that objective through fundamentally different legal mechanisms.
A Convertible Loan Note begins as debt and may later convert into equity, providing the investor with creditor status until conversion.
A SAFE creates a contractual right to receive shares in the future without establishing a lender–borrower relationship.
Neither approach is inherently better than the other. Each offers different advantages, different legal consequences and different commercial considerations.
Choosing the appropriate structure should therefore involve more than selecting the simplest document. It requires careful consideration of the company’s long-term fundraising strategy, investor expectations and future corporate development.
How Forsety Legal Can Help
At Forsety Legal, we advise founders, startups and investors on every stage of the fundraising process. We assist with Convertible Loan Notes, SAFE agreements, investment agreements, shareholders’ agreements and the wider corporate law issues that arise during early-stage financing transactions.
Whether you are preparing your first investment round or considering alternative funding structures, we can help ensure that the legal documentation supports both your immediate financing objectives and your long-term growth strategy.
If you are planning to raise capital and would like to discuss which structure is best suited to your business, we would be pleased to assist.
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