When The Music Stops: SAFEs & Convertible Notes Give VCs Massive Price Protection

It’s simple: It’s easier, faster and cheaper to close funding using Convertible Notes & SAFEs (as compared to a “priced round” in which your startup or growth company issues preferred stock) but SAFEs and Notes also entitle VCs to very heavy duty “Price Protection.” In a prolonged market decline, prices will float down and the Notes and SAFEs of yesterday will convert at painful prices tomorrow; more so than had the startups and growth companies done priced rounds. We’ve known about this for a long time, but the market has been so buoyant, that few have voiced concerns. That’s about to change.

The March 2020 turbulent markets have motivated founders to close on funding swiftly and without friction. That means Convertible Note and SAFE financings will gain market share overpriced rounds. Please remember that BOTH Convertible Notes and SAFEs provide greater “price protection” built into them in favor of the investor than priced rounds do. Please also note, that as my Lowenstein Sandler partner (and Tech Group co-founder), Anthony Pergola, reminds growth companies regularly, if you’re layering Convertible Notes into companies with bank debt, you’ll need to hammer out an intercreditor agreement with the banks or other lenders to get their consent as the Notes will almost certainly need to be subordinate to bank debt. Conversely, banks love to see a bigger cushion of priced equity behind them.

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