What Securities do VCs use to Invest in Startups?

In the U.S., Silicon Valley-style venture capital investments usually use four security types:

Each of these affects your cap table, liquidation outcomes, and startup accounting treatment differently, so founders and finance teams need to understand the basics before signing term sheets.

Convertible Notes: Old‑School Early‑Stage VC

Convertible notes are a traditional way to raise an angel or seed round, or to add “bridge” capital between priced rounds. Technically, this is debt that is designed to convert into equity when you raise a larger priced round later.

Key features:

  • It starts as debt, usually with a modest interest rate (often around 2–3%) and a maturity date (commonly 18–24 months).
  • It almost always converts into preferred stock at the next equity financing, instead of being repaid in cash.
  • It includes a valuation cap (for example, a 10 million dollar cap) that gives early investors a better price than later investors when the note converts.
  • In a liquidation, it behaves like debt and gets paid ahead of equity, which investors like because it reduces downside risk.

From a startup accounting perspective, convertible notes sit on the balance sheet as debt until a qualifying financing event converts them into equity. You also need to track interest accrual and any issuance costs so your financials and cap table reconcile cleanly for investors and auditors.

SAFE (Simple Agreement for Future Equity) notes are a newer, simpler instrument popularized by Y Combinator as a founder‑friendly alternative to convertible notes. Legally, a SAFE is not debt; it is treated more like equity that will convert into stock when a future priced round occurs.

Typical characteristics:

  • No interest rate and usually no fixed maturity date, so there is no compounding interest clock ticking.
  • A valuation cap that functions similarly to a convertible note cap, giving early investors a favorable conversion price.
  • Historically, SAFEs did not include repayment priority, but newer versions increasingly include priority payout features that look more like debt in liquidation scenarios.

On the balance sheet, SAFEs are usually treated as equity or equity‑like instruments instead of debt, so they “look different” in your startup accounting than a convertible note. Your accounting team needs to classify them correctly under GAAP, track the caps and conversion terms, and make sure the eventual conversion to preferred stock ties out to your cap table and fundraising documents.

In practice, Kruze sees a mix of approximately 60% SAFEs and 40% convertible notes at the earliest stages, though the ratio can vary by ecosystem and investor preference.

Preferred Stock: Standard for Priced VC Rounds

Once you move to larger seed, Series A, and later rounds, the standard structure is usually preferred stock. Preferred stock is equity with additional rights and protections that common stock (typically held by founders and employees) does not have.

Most important elements:

  • Liquidation preference: Investors usually get a 1x liquidation preference, meaning they get their invested capital back before common shareholders receive anything. If a startup raises 20 million dollars and sells for 20 million dollars, that entire amount can go to preferred shareholders and common holders may receive nothing.
  • Risk protection: This downside protection lets VCs take more risk on early‑stage companies, since even modest exits can return their capital.
  • Voting rights: Preferred holders often have special voting rights, such as veto power over acquisitions, major financings, or key governance decisions. These rights can be exercised on an “as‑converted” basis (all shareholders together) or on a separate share class basis, giving preferred investors meaningful leverage.
  • Participating vs. non‑participating: In rarer “participating preferred” structures, investors can receive their liquidation preference and then also share pro‑rata in the remaining proceeds, which is more investor‑friendly. Most modern deals use non‑participating preferred, where investors either take their preference or convert to common.

For startup accounting, each round of preferred stock usually gets its own equity account on the balance sheet (for example, Series Seed Preferred, Series A Preferred). You record cash received, par value of shares, and additional paid‑in capital (APIC), and you capitalize direct equity issuance costs (like legal fees) against APIC instead of expensing them.

Highly Structured Preferred: Late‑Stage, Unicorn‑Style Deals

Highly structured preferred stock tends to appear in late‑stage rounds for companies that have previously raised at high valuations but now need more capital without taking an explicit valuation “down round.” These instruments are more complex and look like a hybrid of debt and equity.

Common traits:

  • They often carry a high dividend or interest‑like rate that compounds over time, effectively increasing the investor’s claim.
  • They usually have a senior liquidation preference, sitting above earlier preferred and common in the payout waterfall.
  • The economic return can feel similar to high‑yield debt, but the instrument is labeled as equity, so the company does not appear to lower its valuation.

You rarely see these securities in early‑stage seed or Series A rounds. When they do show up, your startup accounting team and outside counsel must model different exit scenarios carefully, since the waterfall can be significantly more complex than with standard preferred stock.

Why These Securities Matter for Startup Accounting

The securities you choose affect not just dilution, but how your financials look to investors. Solid startup accounting keeps your cap table, legal documents, and financial statements aligned so due diligence goes smoothly and future rounds are easier to close.

A few practical implications:

  • Balance sheet classification: Convertible notes are usually recorded as debt; SAFEs and preferred stock are recorded in equity. Misclassifying them can create issues with GAAP compliance and investor reporting.
  • APIC and financing costs: Direct costs of equity financings (like legal fees) are capitalized and netted against additional paid‑in capital, while debt issuance costs are typically amortized over the life of the loan.
  • Dilution and waterfalls: Your accounting and finance team should model how each security converts and which holders get paid first in different exit scenarios, so founders and employees understand the real economic outcomes.

When your startup’s legal structure and startup accounting are set up with these securities in mind, you present a cleaner, more professional picture to VCs and acquirers. That can make the difference between a slow, painful diligence process and a fast, confident close.