TL;DR — Key Takeaways
- The safe vs convertible note choice is an economics question, not a compliance shortcut. Corporations Code section 25019 defines “security” to include “any note,” any “evidence of indebtedness,” any “investment contract,” and any “warrant or right to subscribe to or purchase” another security – and provides that all of them “are securities whether or not evidenced by a written document.” A note is a security. A SAFE is a security.
- Selling the instrument sells the stock, right then. Section 25017(e) provides that a sale of a convertible security “includes an offer and sale of the other security only at the time of the offer or sale of the … convertible security,” and that “neither the exercise of the right to purchase or subscribe or to convert nor the issuance of securities pursuant thereto is an offer or sale.” The exemption you rely on at the closing has to cover the underlying stock. Conversion later needs nothing.
- Two California notices look interchangeable and are not. Section 25102(f)’s notice is expressly not a condition of the exemption: “The failure to file the notice … shall not affect the availability of the exemption,” though a late filer owes a fee equal to the qualification fee. Section 25102.1(d)’s Form D notice, due “within 15 days of the first sale in this state,” is a stated requirement with no forgiveness clause at all.
- An unqualified, non-exempt sale is a put option held by every investor. Section 25503 lets a buyer recover the consideration paid, with interest and “reasonable attorney’s fees,” on tender of the security – with no scienter, materiality or reliance element – and section 25504 makes directors, principal executive officers and controlling persons jointly and severally liable.
The Direct Answer
Both instruments are securities under Corporations Code section 25019, so both require qualification or an exemption. The practical difference is that a convertible note is an evidence of indebtedness while a SAFE is a right to acquire stock, and under section 25017(e) either one is treated as selling the underlying stock at the time it is issued.
SAFE vs Convertible Note: What California Law Actually Cares About
Not the label. California’s Corporate Securities Law of 1968 asks three questions in order, and the instrument’s name is not one of them.
Is it a security? Section 25019 answers this generously, and its list includes “any note,” “evidence of indebtedness,” “investment contract,” and “warrant or right to subscribe to or purchase, any of the foregoing.” A convertible promissory note is a note. A SAFE is a contractual right to acquire stock on a future event, which is a right to subscribe to or purchase a security and, on any reading, an investment contract. The claim that a SAFE escapes securities law because it is neither debt nor equity has no support in the section.
Is the offer or sale in this state? Section 25008 decides this by where the communication goes, not by where the company was formed. An offer to sell is made in this state when it “originates from this state or is directed by the offeror to this state and received at the place to which it is directed.” A Delaware corporation run from San Mateo, pitching an investor in Oakland, is inside the statute twice over.
Is the transaction qualified or exempt? Section 25110 makes it “unlawful … to offer or sell in this state any security in an issuer transaction” unless it has been qualified or is exempt. There is no third option and no carve-out for a small round.
So the raising capital california startup question is not about the instrument. It is about which exemption the round sits in, whether it stayed inside it, and whether the notice was filed.
What Is a SAFE and How Does It Differ From a Convertible Note?
Commercially, by whether anyone owes anyone money.
A convertible note is debt. It has a principal amount, usually an interest rate, and a maturity date. If it does not convert, it comes due, and the holder is a creditor of the company.
A SAFE – a simple agreement for future equity – is not debt. There is no principal repayable, no interest and no maturity. The investor pays now for the right to receive stock on a defined future event, usually a priced round or a sale of the company. If that event never happens, a SAFE holder generally has no repayment right, which is why some founders prefer SAFEs and some investors do not.
Both instruments carry the same commercial levers, and the levers matter more than the form: a valuation cap, a discount, a most-favored-nation clause, pre-money or post-money conversion, and change-of-control treatment. Two SAFEs with different caps and different pre-money or post-money treatment dilute the founders by materially different amounts, and that is what deserves the modeling time.
Where California law does distinguish them is narrow and appears in section 25102(e), which exempts from qualification “[a]ny offer or sale of any evidence of indebtedness, whether secured or unsecured, and any guarantee thereof, in a transaction not involving any public offering.” A convertible note is an evidence of indebtedness on section 25019’s own list. A SAFE is not.
That asymmetry is real on the text, and this article does not tell you to rely on it: whether subdivision (e) reaches a note whose commercial purpose is conversion into equity is a question no section read here answers, and no case was read on it. It is a question for counsel on your facts, not a route.
Which Securities Exemptions Apply to a California Raise?
For an early-stage company, in practice, one of two – and which one you are in dictates the filing.
Section 25102(f) is the classic private placement exemption, and it requires all four of its criteria:
- “Sales of the security are not made to more than 35 persons, including persons not in this state.” The count is national, not Californian.
- Every purchaser must qualify on relationship or on sophistication. Each either has “a preexisting personal or business relationship” with the issuer or one of its partners, officers, directors, controlling persons or managers, or by reason of their own or their unaffiliated adviser’s “business or financial experience … could be reasonably assumed to have the capacity to protect their own interests.”
- Each purchaser represents they are buying for their own account and not with a view to distribution.
- “The offer and sale of the security is not accomplished by the publication of any advertisement.”
The counting rules are more forgiving than the number suggests. The 35 excludes the institutional purchasers described in subdivision (i), any officer, director or affiliate of the issuer, and any manager of an LLC issuer, and spouses count as one person. So does “a partnership, corporation, or other organization that was not specifically formed for the purpose of purchasing the security offered in reliance upon this exemption” – meaning an existing fund is one person, and a special purpose vehicle assembled for your round is not.
The other route is a federal Rule 506 offering, which California treats as a notice filing rather than an exemption it grants. Section 25102.1(d) says such a transaction is “not subject to” section 25110 if a copy of the completed Form D filed with the SEC is filed with the California commissioner, a consent to service of process is filed with it, and the notice filing fee is paid.
Two more subdivisions matter to founders and are usually missed. Section 25102(h) covers the founding issuance of voting common stock where, after the sale, one class is held beneficially by no more than 35 persons, on conditions including no advertisement and no selling expenses – and it requires a notice “signed by an active member of the State Bar of California” carrying that member’s opinion that the exemption is available. Section 25102(o) covers option and stock purchase plans that are federally exempt under Rule 701, and adds something valuable: offers under it “shall be deemed to be part of a single, discrete offering and are not subject to integration with any other offering.” Granting options during a note or SAFE round does not merge the two.
Section 25102(r) adds an intrastate crowdfunding route, conducted under the federal Rule 147 or 147A and Regulation CF Subpart B, but capped: securities sold in reliance on it in the preceding 12 months “shall not exceed three hundred thousand dollars ($300,000).”
That ceiling is the figure as of drafting; confirm it before you rely on it. The friends and family round legal requirements are simply these requirements applied to people you know. Familiarity satisfies criterion 2 of section 25102(f); it does nothing about the 35-person count, the advertising prohibition, or the filing.
What State Filings Are Required After a Financing?
That depends entirely on the exemption, and this is where the most consequential misunderstanding in the area lives.
Under section 25102(f), the notice is not a condition of the exemption. The statute directs the commissioner to require a notice of transactions by rule, and then says: failing to file the notice, or to file it on time, “shall not affect the availability of the exemption.” A late filer must, within 15 business days after discovering the failure or after the commissioner’s demand, whichever comes first, file the notice and pay “a fee equal to the fee payable had the transaction been qualified under Section 25110.” So the california 25102 filing carries a real cost when it is late, but the exemption itself survives. The form and the deadline come from the commissioner’s rule, which is not reproduced here.
Under section 25102.1(d), the notice is a requirement. The subdivision applies “if all of the following requirements are met,” and the first is a copy of the completed Form D “filed with the commissioner within 15 days of the first sale in this state.” There is no forgiveness clause in section 25102.1 – none for late filing, none for no filing. A founder who files a federal Form D and never files it in California has not obviously satisfied the subdivision’s own condition.
| Exemption relied on | The California notice | Effect of not filing |
|---|---|---|
| Sec. 25102(f) | Notice of transactions required by the commissioner’s rule | Exemption unaffected by statute; late filer owes a fee equal to the Sec. 25110 qualification fee |
| Sec. 25102.1(d) (Rule 506) | Copy of the completed Form D, within 15 days of the first sale in this state, plus consent to service of process and the fee | The subdivision applies only if the requirements are met; the statute states no cure |
Two honest limits. The fee amounts sit in sections 25608 and 25608.1, which were not read for this article, so no dollar figure appears above. And no filing described here is the state’s annual entity compliance – a Statement of Information is a separate obligation that has nothing to do with the raise.
What Can and Cannot Be Said When Soliciting Investors?
Nothing untrue and nothing materially incomplete, in writing or out loud.
Section 25401 is the antifraud provision, and its operative words matter: it is unlawful to offer, sell, buy, or offer to buy a security in this state by a communication containing an untrue statement of material fact, or omitting one “necessary to make the statements made … not misleading.”
Three features of that sentence deserve attention. “Written or oral.” There is no writing requirement. A pitch meeting, a coffee, a WhatsApp voice note and a slide deck are all communications, and the deck is not safer because the number was said out loud rather than typed.
“Omits to state a material fact necessary to make the statements made … not misleading.” A true statement can violate the section if what is left out makes it misleading. A revenue figure that is technically accurate but excludes a customer that has already given notice is the paradigm case.
Nothing about intent. The prohibition contains no scienter element. Under section 25501, a violator is liable to the purchaser, who may sue for rescission or damages, “unless the defendant proves that the plaintiff knew the facts concerning the untruth or omission or that the defendant exercised reasonable care and did not know” of it. Reasonable care is an affirmative defense the founder must prove, not an element the investor pleads.
And the economics of that claim changed recently. Section 25501’s closing sentence, added by legislation operative January 1, 2022, provides that “the court shall award reasonable attorney’s fees and costs to a prevailing purchaser or seller who succeeds in establishing a right to the relief provided by this section.” A mandatory fee award makes a small investor’s claim economically viable in a way it previously was not.
What Are the Consequences of an Unregistered, Non-Exempt Offering?
Rescission, joint and several personal liability, and a short clock – plus a cure route most founders have never heard of.
Section 25503 is the core remedy and it is close to strict. A person who violates section 25110 is liable to the buyer, who may “recover the consideration they paid for that security with interest … and reasonable attorney’s fees,” less income received, on tender of the security. or for damages if they no longer hold it. There is no scienter element, no materiality element and no reliance element. The unqualified, unexempt sale is itself the violation, which means every investor in a defective round holds what amounts to a put option at cost plus interest – exercisable, in practice, exactly when the company’s prospects turn.
Section 25504 answers “the company did the raise, not me.” Every person who directly or indirectly controls a person liable under section 25501 or 25503, every partner in a firm so liable, every principal executive officer or director, everyone in a similar role, “every employee … who materially aids in the act or transaction,” and every broker-dealer or agent who materially aids in it are “liable jointly and severally with and to the same extent as such person” – unless that person “had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability is alleged to exist.”
The limitations periods are shorter than most people expect, and they run in an unusual direction. Section 25507(a) bars a section 25503 action unless brought within “two years after the violation” or one year after the plaintiff discovers the underlying facts, whichever expires first. Section 25506(b) gives the misstatement claim under section 25501 five years from the transaction or two years from discovery, again “whichever shall first expire.” In both, the discovery branch can shorten the period rather than extend it, which is the reverse of how a discovery rule usually behaves.
And the cure exists. Section 25507(b) provides that no buyer may commence a section 25503 action if, before suit, the buyer received a written offer “approved as to form by the commissioner” that states how liability may have arisen, offers repurchase for cash or the amount recoverable under section 25503 or rescission putting the parties back where they started, stays open for “not less than 30 days” after receipt, sets out subdivision (b) itself, and contains whatever else the commissioner requires – and the buyer failed to accept it in writing within that period. The commissioner may condition approval, including by requiring equivalent and concurrent offers to every investor with a potential claim. A blown exemption is therefore fixable, on the state’s terms, if it is found in time.
Criminal exposure exists under section 25540 but requires a willful violation, and an ordinary mistaken exemption is not the case that section describes.
When to Bring Counsel In
Before the first term sheet goes out, and immediately if money has already come in on a handshake.
The before moment matters because the decisions that are cheap now are expensive later. Which exemption the round sits in shapes how many investors you can take, who they can be, and whether you can post about the raise. Section 25017(e) means the exemption has to cover the stock the instrument converts into, so a round designed without that in view has a gap that only shows up at the priced round, during diligence, when there is a term sheet to lose. And under section 25017(a), “any change in the rights, preferences, privileges, or restrictions of or on outstanding securities” is itself a sale, so amending outstanding notes or SAFEs is not a purely administrative act.
The after moment matters because of the clock and the cure. Section 25507(a) runs two years from the violation, and section 25507(b)’s rescission offer needs the commissioner’s approval as to form, which takes time the two-year period does not give back.
Related reading includes whether a C corporation or an S corporation fits a startup, the difference between an LLC and a corporation, what a shareholder agreement should cover, the formation mistakes that cost founders later, and how a business dispute in California actually proceeds.
Work with Bay Legal
Bay Legal, PC advises California founders and investors on financing structure, exemption analysis under Corporations Code sections 25102 and 25102.1, SAFE and convertible note terms, notice filings, and rescission exposure when a round has already closed. Call (650) 668-8000 in Northern California or (213) 668-8000 in Southern California, or schedule a consultation at https://baylegal.com/contact-us/.
Frequently Asked Questions
What is a SAFE and how does it differ from a convertible note?
A convertible note is debt: principal, usually interest, and a maturity date, so a holder who never converts is a creditor. A SAFE has no principal, interest or maturity – the investor pays now for stock on a defined future event. Under California law both are securities under Corporations Code section 25019, and both are treated as selling the underlying stock when issued. The only textual difference is that section 25102(e) addresses evidences of indebtedness, which a note is and a SAFE is not.
Which securities exemptions apply to a California raise?
Most early rounds sit in section 25102(f) or in a federal Rule 506 offering noticed under section 25102.1(d). Section 25102(f) requires all four criteria: no more than 35 purchasers including those outside California, each qualifying through a preexisting personal or business relationship or through business or financial experience, an own-account representation, and no publication of any advertisement. Founding issuances may fit section 25102(h), option plans section 25102(o), and an intrastate crowdfunding route exists in section 25102(r) with a $300,000 ceiling.
What state filings are required after a financing?
It depends on the exemption, and the two common ones behave differently. Section 25102(f)’s notice of transactions is required by the commissioner’s rule, but the statute says failure to file “shall not affect the availability of the exemption” – a late filer owes a fee equal to the qualification fee. Section 25102.1(d) applies only if a copy of the completed Form D is filed with the commissioner within 15 days of the first sale in this state, with a consent to service of process and the fee, and it states no cure.
What can and cannot be said when soliciting investors?
Nothing untrue and nothing materially incomplete, in writing or aloud. Section 25401 reaches “any written or oral communication” that includes an untrue statement of material fact or omits a material fact necessary to make what was said not misleading – so a technically true figure can violate it. There is no intent element; under section 25501 reasonable care is a defense the founder must prove. Since January 1, 2022 the court “shall award reasonable attorney’s fees” to a prevailing purchaser.
What are the consequences of an unregistered, non-exempt offering?
Under section 25503 the buyer can recover the consideration paid, with interest at the legal rate and reasonable attorney’s fees, on tendering the security – with no scienter, materiality or reliance element. Section 25504 extends joint and several liability to controlling persons, principal executive officers, directors and materially aiding employees, subject to a no-knowledge defense. Section 25507(a) gives two years from the violation or one from discovery, whichever expires first.
