SAFEs: How do SAFEs convert?
This week’s question: How do SAFEs actually convert into equity and why does the conversion math matter so much for founders?
Our answer: A SAFE converts when your startup raises its next priced equity round (e.g. a Series Seed or Series A) and follows this general order of operations (i) your startup negotiates a valuation with the new lead investor and the parties agree on the fully diluted capitalization used to calculate the preferred stock price, (ii) all outstanding SAFEs convert into preferred stock immediately before the new investors purchase their shares based on that negotiated valuation and (iii) the new investors purchase their shares at the negotiated price. This sequence means that SAFE investors take their slice first, which reduces the cap table available to the new money and, critically, to the founders. However, new money investors are aware of this structure so they will make sure to receive their desired ownership percentage at the expense of existing stockholders such as the founders. Understanding these mechanics keeps you from tripping during the moment when all early investors suddenly become shareholders overnight.
Key Considerations:
Shadow Preferred Stock. Upon conversion, SAFE investors receive the same preferred stock as the new money priced round investors, but at the discounted price based on the valuation cap and/or the discount rate. To reflect this discounted price, the financing documents create what’s known as a “Shadow Series Preferred Stock” which typically has substantially similar rights as the new Preferred Stock but with a slightly different conversion price to maintain preference stack accuracy. This is mostly a mechanical detail, but founders should keep it in mind so that they understand why multiple series of preferred stock may appear on the startup’s cap table.
SAFEs are Non-Voting. While a SAFE gives no voting or approval rights, founders sometimes forget that when a SAFE converts, those investors join the cap table as preferred stockholders, potentially creating new approval thresholds or blocking rights in future rounds. Founders who don’t anticipate this governance shift and the change in voting and approvals can be caught off guard.
Stacking SAFEs Creates Uneven Dilution. Because each SAFE converts independently based on its own terms, SAFEs with different valuation caps or discount rates convert at different prices and receive very different ownership stakes. As a result, when founders stack SAFEs across a wide range of caps especially over a long fundraising period, this creates layered dilution in which more investor-favorable SAFEs take disproportionately larger portions of the cap table than more company-favorable SAFEs raised later. Each individual SAFE may feel small, but the cumulative effect can be dramatic; so a cap table with multiple mismatched SAFEs can convert into an uneven ownership structure that complicates new financing negotiations and reduces founder control more than expected.
Why It Matters.
The conversion of SAFEs directly determines how much of your company you still own when your startup raises a priced round. Because SAFEs convert before new investors buy in and new investors will always protect their target ownership, the dilution from SAFEs falls heavily on founders. Moreover, multiple SAFEs at different caps can magnify this effect and create a messy and uneven ownership structure that complicates fundraising and weakens founder control. Conversion also triggers an immediate governance shift in that non-voting SAFEs turn into preferred stockholders with real voting power and approval rights. When founders understand these mechanics early and model dilution accurately, they can avoid cap-table surprises and preserve far more negotiating leverage when the priced round arrives.
