The use of convertible notes for seed financing is very common these days in early stage financing.
A convertible note for an early stage financing is generally a short term unsecured loan which converts into shares in a company at a next round financing. SAFE (simple agreement for future equity) was created by Y Combinator to simplify early stage investment. As simplicity is SAFE’s key feature, SAFE is a more straightforward version of the standard convertible note. Both convertible notes and SAFE give their holders a right to convert their notes/SAFE into shares on the occurrence of certain specified events and these instruments convert into shares at a discount to the next round.
More startups are using convertible notes and SAFE as a bridge to their next round financing these days because these deals are quicker to close, which means the startup can get its money quicker than a standard fully negotiated financing round. Most find convertible notes and SAFE attractive because the investors and company do not have to agree a valuation. However, it is common for convertible notes and SAFE to have a valuation cap which is a ceiling on the conversion price of the convertible note and SAFE, thereby allowing the investors to benefit from an upside in the value of the company after their investment.
If your investor is seeking to obtain SEIS or EIS tax relief, please make sure you obtain tax advice because such reliefs are not generally available on convertible notes/SAFE.