Australian startups raising pre-seed and seed capital almost always reach for one of two instruments: a SAFE (Simple Agreement for Future Equity) or a convertible note. Both let founders take in capital before agreeing on a valuation, deferring the pricing conversation to a future equity round. Both are faster and cheaper to close than a priced round. And both carry structural problems under Australian law that founders and investors routinely overlook.
A third option — the convertible equity agreement — has been gaining traction among Australian venture lawyers as a purpose-built alternative that addresses the legal and commercial shortcomings of SAFEs and convertible notes without introducing unnecessary complexity. This article explains where the two standard instruments fall short, what a convertible equity agreement does differently, and when Australian founders should consider using one.
The Problems with Convertible Notes
A convertible note is debt. The company borrows money from the investor. Interest accrues. There is a maturity date by which the note must either convert into equity or be repaid. If a qualifying financing round occurs before maturity, the note converts into shares at a discount to the round price, typically subject to a valuation cap.
The problems for Australian startups are well documented:
Maturity creates a cliff edge. If the company hasn’t raised a priced round by the maturity date, the noteholder can demand repayment. Most early-stage startups cannot repay. This creates a power imbalance at the worst possible time — when the company is already struggling to raise — and can force founders into unfavourable renegotiations or, in extreme cases, insolvency proceedings.
Debt classification has tax consequences. Under Division 974 of the Income Tax Assessment Act 1997 (ITAA97), a convertible note with a non-contingent obligation to repay the principal is classified as a debt interest. This matters because investments classified as debt interests generally cannot qualify as eligible venture capital investments (EVCIs) under the ESVCLP and VCLP regimes. Where qualification is lost, fund managers and their investors miss out on significant tax concessions — including capital gains tax exemptions for non-residents and the 10% non-refundable tax offset for ESVCLP limited partners.
Interest accrual distorts the cap table. Accrued interest increases the amount that converts into equity, meaning the investor receives more shares than the headline investment would suggest. Over an extended period — particularly where maturity is extended — this can produce material and unexpected dilution for founders.
The Problems with SAFEs
SAFEs were designed to solve the problems of convertible notes. By eliminating interest, maturity dates, and repayment obligations, Y Combinator created a simpler instrument that avoids the cliff-edge dynamics of debt. But importing the SAFE model into Australia introduces a different set of issues.
Uncertain legal classification. The SAFE is a creature of US contract law. It is not defined in the Corporations Act 2001 (Cth), and there is no Australian case law establishing how a SAFE is classified for regulatory purposes. Is it a “security”? A “financial product”? Neither label fits cleanly. The government’s guidance on business.gov.au acknowledges that SAFE is “not a term that has recognition in law” and warns founders to focus on the substance of the instrument rather than the label. This ambiguity creates risk: if a SAFE were classified as a financial product or a managed investment scheme interest, different — and more burdensome — regulatory obligations would follow.
No investor protections in a downside scenario. A standard SAFE has no maturity date and no repayment right. If the company never raises a priced round, the investor’s capital is effectively trapped indefinitely. The instrument provides for conversion on a liquidity event or dissolution, but if neither occurs and the company simply stagnates, the SAFE holder has no contractual mechanism to recover their investment. This is by design — the SAFE is meant to be simple — but it can deter sophisticated investors, particularly institutional funds with fiduciary obligations to their limited partners.
ESIC and ESVCLP complications. Whether a SAFE qualifies as an EVCI depends on whether it is classified as a “convertible note that is not a debt interest” under the Venture Capital Act 2002 and the ITAA97. A standard SAFE based on the Australian Investment Council template will typically satisfy this test because there is no effectively non-contingent obligation to repay. But any modification that introduces a repayment right — even a conditional one — can shift the classification and disqualify the instrument from VC tax concessions. Founders who use heavily customised SAFEs without tax advice risk inadvertently creating a debt interest.
What a Convertible Equity Agreement Does Differently
A convertible equity agreement sits between a SAFE and a convertible note. Like a SAFE, it is not debt — there is no interest rate, and there is no obligation to repay the invested amount. Like a convertible note, it includes protective mechanisms that give investors a defined exit path if the company doesn’t raise a qualifying round within a reasonable timeframe.
The key structural features are:
No interest, no debt classification
Because there is no obligation to repay the principal and no interest accrues, a well-drafted convertible equity agreement avoids classification as a debt interest under Division 974 of the ITAA97. This preserves eligibility for VC tax concessions under the ESVCLP and VCLP regimes — a critical consideration for fund managers investing through these structures.
A sunset mechanism instead of a maturity date
Rather than a hard maturity date that triggers a repayment obligation, a convertible equity agreement typically includes a “sunset date” — a date by which, if no qualifying financing or liquidity event has occurred, the investor can elect to convert their investment into equity at a pre-agreed price. This is not a debt repayment right. It is an equity conversion right that prevents the investor’s capital from being locked up indefinitely.
The distinction matters. A maturity date on a convertible note creates a binary outcome: convert or repay. A sunset mechanism on a convertible equity agreement creates a different binary: convert on the investor’s preferred terms, or continue on the existing terms. The company is never at risk of an insolvency-triggering repayment demand.
MFN provisions and information rights
Standard convertible equity agreements typically include most favoured nation (MFN) clauses and basic information rights — provisions that SAFEs often omit but that institutional investors increasingly require. MFN provisions ensure that if the company issues convertible instruments on better terms to a subsequent investor, the earlier investor’s terms are automatically upgraded. Information rights give SAFE-equivalent investors some visibility into the company’s financial position — particularly important given that SAFE holders have no creditor rights and limited standing under the Corporations Act.
Clearer regulatory characterisation
A convertible equity agreement can be drafted to sit squarely within the “convertible note that is not a debt interest” classification contemplated by the Venture Capital Act 2002. By expressly structuring the instrument as a conditional right to receive equity — with no repayment obligation, no interest, and a defined set of conversion triggers — the document avoids the classification ambiguity that affects SAFEs and the debt classification risk that affects convertible notes.
When to Use a Convertible Equity Agreement
A convertible equity agreement is not the right instrument for every situation. For a straightforward angel raise where speed and simplicity are paramount and the investor is comfortable with a standard SAFE, there is no reason to add complexity. Similarly, where an investor specifically wants debt treatment — because they want priority in a liquidation or because their mandate requires debt instruments — a convertible note remains the appropriate choice.
A convertible equity agreement makes the most sense when:
- You’re raising from institutional investors or VC funds that invest through ESVCLPs or VCLPs and need the investment to qualify as an EVCI.
- Your investors want downside protection beyond what a SAFE provides, but you want to avoid the maturity cliff and debt classification of a convertible note.
- You’re stacking multiple convertible instruments before a priced round and want to include MFN provisions and information rights to keep all investors aligned.
- You want regulatory clarity — an instrument that is clearly a convertible note (not a debt interest) under the tax legislation, without relying on the argument that a SAFE fits that category despite having no statutory definition.
Structuring Considerations for Founders
If you’re considering a convertible equity agreement for your next raise, several structural choices will determine whether the instrument achieves its objectives:
Valuation cap and discount. These operate the same way as in a SAFE or convertible note. A valuation cap sets the maximum company value at which the investment converts; a discount gives the investor a percentage reduction on the price paid by new investors in the priced round. Most convertible equity agreements include both.
Sunset date. Typically set at 18 to 24 months from the date of investment. Too short, and you pressure yourself into a premature priced round. Too long, and the investor loses the protection the mechanism is designed to provide. The sunset conversion price should reflect the valuation cap — otherwise you create misaligned incentives.
Qualifying financing threshold. Define what constitutes a “qualifying” equity round that triggers automatic conversion. The threshold should be high enough that trivial share issuances don’t trigger conversion, but low enough that a genuine institutional round does. A dollar amount (e.g., $1 million or more in aggregate proceeds) is standard.
Dissolution waterfall. Specify where convertible equity agreement holders sit in a dissolution. They should rank ahead of ordinary shareholders but behind secured creditors — similar to a SAFE, but expressly stated rather than implied.
Anti-dilution and MFN. Include broad-based weighted average anti-dilution protection on conversion, and an MFN clause that automatically upgrades terms if the company issues convertible instruments on more favourable terms before the next priced round.
The Bigger Picture
The Australian startup fundraising market has matured significantly, but the instruments used to raise early-stage capital have not always kept pace. SAFEs remain popular because they are fast and familiar, but their uncertain legal status and lack of investor protections create risks that become more acute as round sizes grow and institutional investors enter the picture. Convertible notes solve some of those problems but create others — particularly around debt classification and the maturity cliff.
Convertible equity agreements represent a considered middle ground. They are not a radical departure from existing instruments — they borrow heavily from both SAFEs and convertible notes — but they are structured specifically for the Australian legal and tax framework in a way that neither of the imported alternatives fully achieves.
For founders raising from sophisticated investors who care about EVCI qualification, and who want clean conversion mechanics without the risks of debt classification, a convertible equity agreement is worth the conversation with your lawyer.
Viridian Lawyers advises Australian startups and investors on fundraising, corporate structuring, and venture capital transactions. If you’re considering a convertible equity agreement for your next round, get in touch.
