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  • A startup is asking me to convert my SAFE – should I convert the SAFE to stock?

    Posted by Brian on September 29, 2022 at 9:34 pm

    One of your startups raised a new funding round – congrats! Now they are giving you the option to convert your SAFE into stock (Common or Preferred). The question is – should you convert your SAFE into stock?

    First, whether or not you even have the option (and won’t be required to convert) depends on your SAFE. Some SAFEs and Convertible Notes will convert automatically at the next qualified financing; other SAFEs may only convert at the issuer’s choice; and yet other SAFEs may give the investors the option to convert.

    While the pros and cons below will be from the investor’s perspective, understand that sometimes there are also reasons that it could be beneficial for the issuer to ensure that all investors convert their SAFEs into equity. Sometimes having a bunch of SAFE-holders may be a deterrent for potential later-stage investors, so a lack of investors converting their SAFEs could could hurt the company’s ability to raise future funding rounds, which in turn could hurt the company’s (and those same investors’) chance at success.

    Benefits of NOT Converting your SAFE

    From the investor’s perspective, there are very few reasons you might choose to not convert your SAFE.

    Potential to reduce Dilution: If you choose not to convert your SAFE at the current round, you are hoping that your company will raise another round of financing so that you can then convert at a later round. The potential benefit of that is that if your investment company raises more capital before then, you won’t get diluted if you don’t convert.

    You’ll get the same SAFE conversion price at a later round, so you could theoretically save on dilution.

    Downsides of NOT Converting your SAFE

    The cons of not converting your SAFE at the first opportunity are as follows (and there are likely more).

    1. You might miss out on QSBS tax benefits: If you don’t convert your SAFE in the current round, you won’t technically own “equity” in the company, so the 5 year clock for Qualified Small Business Stock (QSBS) won’t start until you convert (if your investment would qualify for that). And QSBS can be very beneficial, giving investors up to 100% tax-free gains on qualifying investments!
    2. You might not get liquidity that you could get with stock: Signing SAFE conversion paperwork may also unrestrict your shares under Rule 144 (I’ve seen this done at the same time as SAFE conversion a few times). This means that – if you wanted to – you could then transfer and sell the shares on a secondary market, if and when that exists for those shares.
    3. You might miss out on dividends paid to stockholders: If they pay out dividends (usually startups don’t), you won’t get dividends with the SAFE, but you would with the stock
    4. You won’t be able to vote while holding a SAFE: If the granted stock shares would give you voting rights (which isn’t very typical with crowdfunding shares), then you’d be missing out on the opportunity to vote and influence the destiny of the company you invested in.
    5. You may have different rights in the event of a liquidation: Depending on the types of shares that the SAFE would convert into, you may end up with different rights in the event of a liquidation or a sale.

    Many investors will choose to convert the SAFE at the earliest opportunity for the above reasons. However, each investor is unique, so there may be instances where you choose not to convert. Always consider the risks and tradeoffs of each option before making your decision.

    • This discussion was modified 1 year, 8 months ago by  Brian.
    • This discussion was modified 1 year, 8 months ago by  Brian.
    Brian replied 1 year, 8 months ago 1 Member · 0 Replies
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