Introduction

Convertible notes, Simple Agreements for Future Equity (SAFEs) and warrants are widely used in startup capital raising in Australia, particularly across early and growth-stage funding. Each offers a way to raise capital or provide equity upside without immediately issuing shares, but each operates differently and involves distinct trade-offs.

In this article our capital raising lawyers take a practical look at the pros, cons and common pitfalls of each instrument, to help founders and growth-focused businesses assess how they may affect dilution, timing and outcomes as their business grows.

Pros and Cons of Using Convertible Notes

In Australian startup capital raising, choosing whether to use a convertible note involves balancing its practical benefits against potential drawbacks. The structure of the note can affect timing, dilution and how smoothly a future equity round progresses, making it important for founders and growth-focused businesses to understand these trade-offs.

Pros

Convertible notes are often attractive because they:

• allow businesses to raise capital quickly;
• avoid the need to issue equity immediately;
• provide a practical bridge to a future priced round;
• require less documentation and negotiation than a full equity round; and
• may defer valuation discussions until more information is available.

Cons

Convertible notes are not risk-free, and using them brings a number of considerations, including:

• potential dilution depending on how caps, discounts and interest interact;
• maturity dates that may require conversion or repayment if no qualifying round occurs;
• complexity when multiple notes are issued on differing terms; and
• the risk that investor protections or redemption rights become burdensome if circumstances change.

In practice, these issues most often arise where notes are issued across multiple tranches without consistent modelling or alignment with future funding plans.

For a detailed breakdown of convertible note terms, see our article Convertible Notes – A Term-by-Term Guide for Founders and Growing Businesses.

SAFEs: the Pros and Cons

For some businesses, the constraints associated with convertible notes – particularly interest accrual and maturity dates – prompt consideration of alternative structures. In those circumstances, SAFEs are often used due to their relative simplicity at the point of issue. However, while SAFEs remove certain pressures associated with convertible notes, their practical impact is typically felt later. 

Pros

SAFEs are often attractive because they:

• allow capital to be raised quickly without setting a valuation upfront;
• avoid interest accrual and maturity dates;
• defer changes to the cap table until a priced equity round or other trigger event; and
• provide flexibility in early-stage fundraising where timing and valuation remain uncertain.

Cons

At the same time, SAFEs involve a number of considerations, including:

• deferred dilution that may be difficult to assess without modelling;
• conversion outcomes that depend heavily on caps, discounts and capitalisation definitions; and
• exit and downside outcomes that may crystallise before any priced equity round occurs.

Because SAFEs do not include the same structural constraints as debt instruments, the commercial outcome is often concentrated in the conversion mechanics, making upfront modelling particularly important.

For a detailed explanation of SAFE mechanics and key terms, see our article Understanding Simple Agreements for Future Equity – a guide to common terms in SAFEs.

Warrants: Pros and Cons

Warrants are structurally different from convertible notes and SAFEs. Unlike instruments that defer the issuance of equity until a defined trigger event, a warrant gives the holder a right (but not an obligation) to acquire shares at a fixed price within a defined period. In the Australian market, warrants are typically issued alongside another commercial or financing arrangement rather than on a standalone basis.

Pros

Warrants are often attractive because they: 

• provide equity upside without immediate dilution;
• align incentives by linking upside to business performance and exercise; and
• can be used to improve terms in related transactions, such as reducing cash pricing or fees.  

Cons

At the same time, warrants can introduce complexity that is not always apparent at the outset. In particular:

• potential dilution if and when warrants are exercised;
• complexity around exercise timing, vesting and expiry; and
• the risk that pricing or coverage levels result in greater dilution than anticipated. 

These issues are most pronounced where warrants are issued alongside other instruments and are not incorporated into fully diluted modelling at the time of issue. 

Common Pitfalls Across Instruments

Across convertible notes, SAFEs and warrants, issues rarely arise from the instruments themselves. They more often result from how these instruments are layered over time or used without a clear capital raising strategy.

In practice, the most common pitfalls include:

• Unexpected dilution on conversion or exercise

Where multiple instruments are issued over time, the combined dilution may only become apparent at a priced round or exit. This is particularly common where caps, discounts and warrant coverage have not been modelled on a fully diluted basis.

• Inconsistent commercial terms across instruments

Differences in valuation caps, discounts, capitalisation definitions or conversion mechanics can lead to uneven economic outcomes between investors and create friction in later funding rounds.

• Dilution overhang from unexercised rights

Outstanding SAFEs, notes and warrants can create a volume of potential equity that is not reflected in the current share register, but will be factored into pricing and negotiations by incoming investors.

• Misalignment with new investors at a priced round

New lead investors will typically assess the fully diluted position, including all conversion and exercise rights. Where earlier instruments have not been structured consistently, this can result in renegotiation, restructuring or delays to completion.

• Timing risks and structural pressure points

Features such as maturity dates (for notes), exercise windows (for warrants) or exit mechanics (for SAFEs) can create pressure if funding or growth does not occur as expected. These issues often arise at the least convenient time – immediately prior to a funding event or exit.

• Over-reliance on simplicity at the point of issue

Instruments that appear simple when issued – particularly SAFEs – may produce complex outcomes later, as the economic position is largely determined by conversion mechanics rather than upfront pricing.

From a capital raising perspective, these issues are typically identified at the point of a priced round or exit, when the fully diluted position is tested. These risks are not inherent flaws in alternative financing instruments. They are typically structural and can be mitigated through:

• early modelling on a fully diluted basis
• consistency of terms across instruments
• clear capitalisation definitions
• alignment with future funding strategy

This is one of the key reasons why early engagement with experienced capital raising lawyers is critical.

The choice of instrument is rarely the issue – the risk sits in how multiple instruments interact over time. Understanding dilution on a fully diluted basis before issuing new instruments is critical to avoiding unexpected outcomes at a priced round or exit. 

For a more detailed analysis of how these instruments interact within the capital stack, see our article How Convertible Notes, SAFEs and Warrants Work Together in the Capital Raising Stack 

The Wrap Up

Convertible notes, SAFEs and warrants each offer different ways to raise capital or provide equity upside, and each involves distinct trade-offs around timing, dilution and risk. No single instrument is right in every case; suitability depends on the company’s stage, funding strategy and future plans.

Understanding how these instruments operate in practice and how their terms interact over time helps founders and growing businesses make more informed capital raising decisions as they raise capital and scale.

Our capital raising lawyers work closely with founders and businesses to structure and negotiate these instruments, and can assist if you would like to discuss your position