SAFE / convertible note / preferred shares — reading a term sheet in numbers
🎯 Goal: Understand early-stage instruments (SAFE, convertible note, preferred shares) and know how to COMPUTE how a SAFE with a valuation cap & discount converts into shares at the next round.
At early stages, valuing a company is very hard, so both sides use "defer-the-valuation" tools: the SAFE (an agreement for future equity, created by Y Combinator — the "YC SAFE") and the convertible note (an interest-bearing loan that converts to equity). At a priced round, investors usually take preferred shares. The summary of terms is the term sheet — read four items that directly hit your equity & exit money: valuation cap, discount, liquidation preference, and pro-rata. You'll leave able to compute a SAFE's conversion and how much extra a cap/discount dilutes you.
Lesson content
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Early-stage instruments. • SAFE (Simple Agreement for Future Equity, created by Y Combinator — the "YC SAFE"): the investor gives money now for the right to receive shares at the next priced round. Not debt, no interest, no maturity. • Convertible note: like a SAFE but essentially an interest-bearing loan with a maturity, that "converts" to shares later (or must be repaid if it doesn't). Both defer the valuation when the company is too young to price. At a priced round (seed/Series A), investors usually take preferred shares with priority rights.
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Framework: 4 terms to scrutinize. Four items directly affecting your equity and exit money: 1) Valuation cap — a ceiling valuation for converting the SAFE/note; a lower cap → the investor gets more %. 2) Discount — early investors buy cheaper than the next round (e.g. −20%); bigger discount → more dilution for you. 3) Liquidation preference — on a sale/liquidation, preferred investors get paid first (e.g. 1x capital); high multiples (2x, 3x) → less left for founders/staff. 4) Pro-rata — the investor's right to invest more later to keep their %. SAFE rule: conversion price = the lower of (price at the cap) and (next-round price × (1 − discount)) — whichever gives the investor more shares applies.
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TOOL: Convert a SAFE in numbers. An investor puts 1bn via a SAFE with a 20bn cap and a 20% discount. The next round prices at 40bn pre-money. Compare the paths (pick the one giving the investor more shares = lower price):
Conversion path
Valuation used
SAFE % ≈
At next-round price (no SAFE)
40bn
1÷40 ≈ 2.5%
Via discount −20%
40 × 0.8 = 32bn
1÷32 ≈ 3.1%
Via the 20bn cap (wins)
20bn
1÷20 = 5.0%
The cap "wins" because it gives the investor the most shares: they're priced as if the company were worth only 20bn, though the next round is 40bn. Result: the SAFE investor gets ~5% instead of 2.5% — that gap is the early-risk reward, and also the extra dilution founders bear.
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Vietnam comparison (step by step). 1) "Preferred shares" are defined in the Enterprise Law (voting/dividend/redemption preferences...). 2) Many US-style SAFE/convertible-note terms must be "translated" into a VN legal structure via contracts, the charter, a shareholders' agreement. 3) Regional funds (Do Ventures, 500 Global, Vertex Ventures...) are used to international structures, sometimes setting up an offshore entity to use a standard SAFE. 4) So a real term sheet always needs a lawyer's review before signing — one line of "cap" or "3x participating" can change the whole exit outcome.
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Toxic-term traps: • Cap too low: the investor converts into lots of shares → founders surprisingly heavily diluted later. • Discount stacked on cap: some SAFEs allow both — read the mechanics carefully. • High-multiple liquidation preference + "participating": the investor takes 2x–3x first and still shares the rest → founders/staff nearly empty-handed at a modest exit. • Too many stacked SAFEs: at the priced round, total converted shares are bigger than you thought. Content is for LEARNING only, not financial/legal advice.
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Checklist to read a SAFE/term sheet: ① Is it a SAFE (no interest) or a convertible note (interest + maturity)? ② What is the cap — convert it into the investor's % at a few next-round valuations. ③ Is there a discount, how much, applied with the cap or "whichever is better for the investor"? ④ How many "x" is the liquidation preference, and is it "participating"? ⑤ Is there a pro-rata right — must I leave "room" next round? ⑥ Has a lawyer read it before signing?
Practice exercise
🔬 APPLIED EXERCISE (compute it): You sign a SAFE taking 500m with a 10bn cap and a 20% discount. The next round prices at 25bn pre-money. Compute the SAFE investor's % via all three paths (next-round price, discount, cap), show which "wins", and explain the good/bad for founders.
Worked template: ANSWER: (a) at next round: 0.5 ÷ 25 = 2.0%. (b) via discount: price = 25×0.8 = 20bn → 0.5 ÷ 20 = 2.5%. (c) via the 10bn cap → 0.5 ÷ 10 = 5.0% (WINS, most shares). The SAFE investor gets ~5% instead of 2%. Good for the investor (early-risk reward), bad for founders — ~3 extra points of dilution — so consider not setting the cap too low.
Quick quiz
1. What do a SAFE and a convertible note have in common?
→ Both DEFER the valuation, converting into shares at a later round
SAFE and convertible note both defer the valuation, converting into shares at a later round.
2. The core difference between a SAFE and a convertible note is:
→ A SAFE is not debt/no interest; a convertible note is an interest-bearing loan with a maturity
Core difference: a SAFE is not debt, no interest; a convertible note is an interest-bearing loan with a maturity.
3. SAFE 1bn, cap 20bn, discount 20%; next round pre-money 40bn. Which path gives the investor the most shares?
→ Via the cap (20bn) → 5.0%
The 20bn cap gives the lowest conversion price (20bn) vs the discount (32bn) and next-round price (40bn) → the investor gets the most shares (5%).
4. What right does a "liquidation preference" give an investor?
→ To get money back BEFORE other shareholders when the company is sold/liquidated
Liquidation preference lets investors get money back before other shareholders on a sale/liquidation.
5. How does a low valuation cap affect founders?
→ A low cap lets the investor convert into more shares → founders diluted more
A low valuation cap lets investors convert into more shares → founders are diluted more.
6. What does a "pro-rata" right give an investor?
→ To invest more in later rounds to keep their %, avoiding dilution
Pro-rata gives investors the right to invest more later to keep their %, avoiding dilution.
Advanced
A deeper framework
At an advanced level, understand that cap and discount don't naively add up: the standard YC SAFE lets the investor use whichever path is better (the lower conversion price = more shares), usually the cap when the next round prices high. Only when the next round prices below the cap does the discount bite.
The most exit-critical term is the liquidation preference. "1x non-participating" is fairly benign: the investor either takes 1x capital or converts to common by %. But "3x participating" means taking 3x capital first and still sharing the rest by % — at a modest exit, founders and staff can end up nearly empty-handed even if the company "sold for a good price".
The investor gets 30 + 2 = 32bn of 40bn (80%!) despite holding just 20% of equity. "3x participating" is a classic toxic term at a modest exit.
Common trap: Looking only at a "high" valuation and ignoring the liquidation preference. A high valuation with "2x–3x participating" can be worse than a lower valuation with "1x non-participating", because most exit money flows to the investor first. Always ask the multiple and "participating or not".
Advanced questions
1. Next round prices at 40bn; SAFE has a 20bn cap and 20% discount. Which path applies?
→ The 20bn cap, because it gives a lower conversion price (more shares) than the discount (32bn)
The SAFE picks the path better for the investor = the lowest conversion price. The 20bn cap < the discounted 32bn, so the cap applies and the investor gets more shares.
2. How does "3x participating" differ from "1x non-participating"?
→ 3x participating: take 3x capital first AND still share the rest → founders get very little at a modest exit
1x non-participating: the investor takes 1x or converts to % — fairly benign. 3x participating: take 3x first and still share by %, eating most of a modest exit and leaving little for founders/staff.
3. Why isn't a "high valuation" necessarily the better deal?
→ Because with a high-multiple/participating preference, most exit money flows to the investor first, leaving founders less than a lower valuation with benign terms
What founders actually receive depends on BOTH the valuation AND the exit-sharing terms. A high valuation + 3x participating can leave less than a lower valuation + 1x non-participating.
🎯 Real-life mission
REAL-LIFE MISSION: Find a YC SAFE template or a public term sheet. Read it and note 4 terms: valuation cap, discount, liquidation preference, pro-rata — one sentence each in your own words. Then set your own numbers (SAFE + cap + discount + next-round valuation) and compute the investor's % via all three paths, showing which wins. Remember: for learning only; a real term sheet needs a lawyer.