When a financing instrument becomes a corporate problem
An early-stage company signs three SAFE agreements within two weeks, each with a different investor and slightly different terms. The funds hit the bank account, the founders get back to running the business, and the signed documents sit in a shared folder. It is only when the first institutional funding round arrives that the gaps surface: there is no properly documented board resolution authorizing the issuance, the company's registered share capital is insufficient to cover the anticipated conversion, and the articles of association do not actually support the conversion mechanism the parties agreed to.
Convertible notes and SAFEs have earned a reputation as simple, fast fundraising tools, and commercially, they are. But under Israeli corporate law, every such issuance is a full corporate act, subject to the Companies Law, 5759-1999, and to the company's own articles of association. This article examines the corporate considerations that deserve attention before signing, not just the economic terms of the instrument itself.
What the instrument actually is under corporate law
A convertible note is typically structured as an interest-bearing loan that converts into shares upon a defined triggering event, usually a future financing round. A SAFE (Simple Agreement for Future Equity) is not a loan at all. It is an agreement granting the investor a right to receive shares in the future, with no interest component and no maturity date. This distinction directly affects how the instrument should be classified on the company's books and how it should be treated in corporate decision-making.
It is important to understand that neither instrument is a "share" at the time of signing. Both create a contractual right to a future share allotment, and only at the actual conversion date does the corporate act of issuing equity take place. This means the company needs to plan in advance what that future allotment will look like, not only negotiate the conversion terms themselves.
Corporate approvals required to issue the instrument
Issuing a convertible note or SAFE generally requires a board resolution approving the transaction itself, its principal terms, and the authorization of officers to execute the documents. In many cases, shareholder approval is also required, particularly where the prospective allotment may exceed the company's registered share capital, or where existing interested parties are among the investors.
When a founder or existing shareholder participates in the round through a convertible instrument, the company should assess whether the transaction qualifies as a related-party transaction requiring the special approval process set out in the Companies Law provisions governing transactions with controlling shareholders and officers. Skipping this step can expose the resolution to later challenge and complicate due diligence in subsequent rounds.
- A detailed board resolution approving the instrument's terms and the overall framework of the raise
- Assessing whether shareholder approval is required, based on the articles of association and the scope of the prospective allotment
- Checking for rights of first refusal or tag-along rights that may apply to the future allotment
- Properly documenting all resolutions in valid minutes, for presentation in future due diligence
Conversion mechanics and their effect on capital structure
The conversion mechanism determines how and when convertible notes or SAFEs turn into shares. In most cases, conversion occurs automatically upon a future financing round, based on a discount to the round's share price, a valuation cap, or a combination of both. From a corporate standpoint, this means that at the conversion date the company must allot shares to multiple investors simultaneously, at different rates, according to the terms of each individual instrument.
A common problem arises when the registered share capital in the articles of association is insufficient to cover the anticipated conversion, or when multiple instruments with different valuation caps produce conflicting dilution outcomes. It is advisable to model dilution scenarios (cap table modeling) in advance, before signing any additional instrument, to confirm that the proposed mechanism can actually be implemented within the existing capital structure.
Special attention should also be paid to Most Favored Nation (MFN) provisions, which give earlier investors the right to adopt more favorable terms granted to later investors. If not carefully drafted, such a clause can trigger a chain of adjustments that significantly complicates the allotment calculation at conversion.
Aligning the articles of association and the cap table
The articles of association are the corporate document that determines which classes of shares may be allotted and on what terms. Where a convertible note or SAFE is expected to convert into a share class not yet defined in the articles (for example, a specific series of preferred shares), the articles should be amended in advance, or at minimum, a mechanism should be put in place allowing the board alone to create that share class by resolution at the time of conversion, without needing to convene a shareholders' meeting at that critical stage.
The cap table should be updated on an ongoing basis and should reflect outstanding, not-yet-converted instruments, including conversion scenarios under different valuation caps. Many companies use dedicated tools to manage a dynamic cap table, but it is worth remembering that these are management tools only. The binding legal documents are the board resolutions, the meeting minutes, and the articles of association themselves, not the spreadsheet.
Governance and reporting considerations
Raising capital through convertible notes or SAFEs does not exempt a company from its ongoing reporting obligations under the Companies Law and its regulations, including updating the shareholders' register and reporting to the Companies Registrar once shares are actually allotted upon conversion. Every future allotment should be properly documented as soon as it occurs, rather than left pending until the next external audit.
In companies with an active board that includes directors appointed by existing investors, it is advisable to bring the decision to issue a new convertible instrument to a properly conducted board discussion, rather than relying solely on a blanket written consent. This reduces future exposure to claims of breach of the duty of care or duty of loyalty by officers, particularly where the terms of the new instrument differ materially from those the company previously issued.
Practical recommendations before signing
Before a company signs another convertible note or SAFE, it is worth conducting a corporate review, not just an economic one. That review should include the following points:
- Confirming that the registered share capital in the articles of association is sufficient to cover all anticipated conversion scenarios, including combined dilution scenarios
- Obtaining a detailed, documented board resolution for each instrument individually, even when it is an add-on to an existing round
- Assessing whether shareholder approval is needed, particularly when interested parties are involved or the allotment exceeds the existing framework
- Keeping the cap table continuously updated, with documented conversion scenarios for each outstanding instrument
- Reconciling MFN provisions, valuation caps, and discounts across instruments issued at different times
An accumulation of convertible instruments without organized corporate management is one of the most common causes of delay in institutional financing rounds, where counsel for the incoming investor closely scrutinizes the chain of corporate approvals that preceded them. Investing in orderly corporate infrastructure at an early stage saves valuable time and reduces legal risk further down the road.
The information contained in this article is general in nature and does not constitute legal advice. For advice tailored to the specific circumstances of your company, we invite you to contact our firm.
