What is a convertible loan agreement (and a SAFE)?
Is a convertible loan or SAFE enforceable in South Africa?
“The board of a company may issue authorised shares only— (a) for adequate consideration to the company, as determined by the board; (b) in terms of conversion rights associated with previously issued securities of the company; or (c) as a capitalisation share as contemplated in section 47.”
“An issue of shares, securities convertible into shares, or rights exercisable for shares in a transaction, or a series of integrated transactions, requires approval of the shareholders by special resolution if the voting power of the class of shares that are issued or issuable as a result of the transaction or series of integrated transactions will be equal to or exceed 30% of the voting power of all the shares of that class held by shareholders immediately before the transaction or series of transactions.”
“If a private company proposes to issue any shares, other than as contemplated in subsection (1)(b), each shareholder of that private company has a right, before any other person who is not a shareholder of that company, to be offered and, within a reasonable time to subscribe for, a percentage of the shares to be issued equal to the voting power of that shareholder’s general voting rights immediately before the offer was made.”
When you need a Convertible Loan & SAFE
- A founder is raising a seed or bridge round and wants to take in money fast without first negotiating a company valuation — deferring the pricing question to the next, larger funding round.
- An angel investor or accelerator is putting in early capital and wants the upside of a valuation cap and/or a discount on the price the next round's investors will pay, plus a clear conversion trigger.
- A company needs a short runway extension between priced rounds (a "bridge") and wants the bridge money to roll into the next round's shares rather than being repaid in cash it does not have.
- A South African startup wants the simplicity of a SAFE (no interest, no maturity date, no creditor on the balance sheet) rather than a debt-style convertible note with a repayment fallback.
- You are preparing for due diligence or a Series A and need the existing convertibles, valuation caps, discounts and conversion mechanics documented and reconciled so the cap table is clean and section 41 approvals are in place.
What a Convertible Loan & SAFE should contain
Conversion trigger (qualifying financing round)
Define exactly what causes conversion — typically a "qualifying financing" (a priced equity round above a stated minimum amount), but also deal with the optional/voluntary conversion, and what happens on a sale of the company or an IPO. The trigger is the heart of the instrument; vague triggers cause disputes about whether and when shares must be issued.
Valuation cap and discount
Set the valuation cap (the maximum company value used to price the investor's conversion shares) and/or the discount (commonly 10–25%) to the new round's share price. State clearly whether the investor gets the better of cap or discount, and how the conversion price and number of shares are calculated, so the cap-table effect is certain.
Maturity, interest and repayment fallback (notes only)
A convertible note is debt: specify the maturity date, any interest rate (and whether interest also converts), and what happens if no qualifying round occurs by maturity — convert at a default valuation, extend, or repay. A SAFE deliberately omits all of this (no interest, no maturity), which is the key drafting choice between the two instruments.
Companies Act share-issue mechanics (s 38–41)
Build the conversion to comply with the Companies Act: confirm the MOI authorises enough shares of the right class (s 36/38), provide for the board issue resolution (s 38), and address the s 41 special resolution where the holder is a director/related person or the conversion crosses the 30% voting-power threshold. Section 40(1)(b) expressly permits issuing shares on conversion rights.
Pre-emption waiver and existing-shareholder consents
Section 39 gives existing private-company shareholders a pre-emptive right over new shares. Secure a waiver or confirm the MOI disapplies it, and obtain any consents required under a shareholders' agreement, so the conversion issue cannot be unwound for breaching pre-emption.
Most-favoured-nation and pro-rata / information rights
Address whether the investor gets MFN treatment (the benefit of better terms given to later convertible investors), a pro-rata right to participate in the next round, and what information the company must provide. These investor-protection terms are standard in SAFEs and notes and shape the downstream cap table.
Conditions, warranties and what converts into
Specify the class and rights of the shares the investor receives on conversion (often the same preferred/ordinary class as the new round), the company warranties given at signing, conditions precedent, and treatment of accrued interest. Ambiguity here turns conversion into a renegotiation at the worst possible time.
Convertible note vs SAFE in a South African early-stage raise
| Feature | Convertible loan note | SAFE (Simple Agreement for Future Equity) |
|---|---|---|
| Legal nature | A loan — debt that converts into shares | Not a loan — a contractual right to future shares |
| Interest | Usually accrues (and often converts too) | None — carries no interest |
| Maturity / repayment | Has a maturity date and a repayment-or-convert fallback | No maturity date; only converts on a trigger |
| On the balance sheet | Sits as a creditor / liability until it converts | Not classic debt — closer to a future-equity instrument |
| Pricing levers | Valuation cap and/or discount; interest sweetens the deal | Valuation cap and/or discount only |
| Companies Act on conversion | Shares issued under s 38–41; s 40(1)(b) covers conversion | Same — the share issue on conversion still runs s 38–41 |
Common South African pitfalls
- Treating the signed note or SAFE as the whole transaction. The contract binds the parties, but the conversion is a Companies Act share issue: if the MOI has no authorised shares of the right class, or the board issue resolution and any section 41 special resolution are missing, the conversion can be invalid or challengeable when it matters most.
- Ignoring section 39 pre-emptive rights. Existing private-company shareholders have a statutory right to be offered new shares pro-rata before outsiders. If that right is not waived or disapplied in the MOI, the conversion issue can be attacked by a diluted shareholder.
- Missing the section 41 special-resolution triggers. A 75% special resolution is required where convertible securities are issued to a director, future director, prescribed officer or a related/inter-related person, or where the shares issuable on conversion reach 30% or more of the voting power of that class — easy to overlook when an investor is also a director.
- A valuation cap or discount that produces a punishing conversion. An aggressive cap (or stacked caps and discounts across several notes) can hand convertible holders far more equity than founders expected at the next round; model the fully-diluted cap table before signing, not after.
- Assuming the National Credit Act never applies. Most convertible notes to a juristic-person borrower are outside the NCA (the company exceeds the R1 000 000 threshold, or the investor and company are not at arm's length), but a note to a small startup borrower below the threshold, lent at arm's length, can be caught — check it rather than assume.
- Leaving the maturity fallback vague (notes). If a convertible note reaches maturity with no qualifying round, silence on what happens — convert at a default valuation, extend, or repay — turns a routine event into a dispute, often when the company can least afford to repay cash.
Frequently asked questions
What is the difference between a convertible note and a SAFE in South Africa?
A convertible note is a loan: it accrues interest, has a maturity date and converts into shares on a trigger, with cash repayment as a fallback. A SAFE is not a loan — it has no interest and no maturity, and is simply a right to future shares. Both are enforceable in South Africa, and in both cases the actual share issue on conversion must comply with the Companies Act 71 of 2008.
Is a SAFE legal and enforceable under South African law?
Yes. A SAFE is an ordinary contract and is enforceable under South African common law — no statute prohibits it. The one thing it cannot do by itself is issue shares: when the SAFE converts, the company must follow sections 38 to 41 of the Companies Act, including ensuring the MOI authorises the shares and obtaining any required special resolution.
What triggers conversion of a convertible loan?
The standard trigger is a "qualifying financing" — the company's next priced equity round above a stated minimum amount, at which the loan automatically converts into shares. Agreements usually also cover conversion on a sale of the company, an IPO, voluntary conversion, and a maturity-date fallback. The trigger and the conversion-price formula (cap and/or discount) should be defined precisely to avoid disputes.
How do the valuation cap and discount work?
The valuation cap is a ceiling on the company value used to price the investor's conversion shares, so early backers are not penalised if the next round prices the company high. The discount (commonly 10–25%) gives the investor a lower per-share price than the new round's investors. Where both apply, the investor usually converts at whichever produces the better (cheaper) price.
Which Companies Act sections apply when a convertible converts into shares?
Sections 38 to 41 of the Companies Act 71 of 2008. The MOI must authorise the shares (s 36/38), the board resolves to issue them (s 38), and section 40(1)(b) expressly allows issuing shares "in terms of conversion rights associated with previously issued securities". Section 39 pre-emptive rights and section 41 special-resolution approvals (director/related-party issues and the 30% voting-power threshold) must also be addressed.
Does the National Credit Act apply to a convertible loan?
Usually not when the borrower is a company. The National Credit Act 34 of 2005 does not apply to a credit agreement where the juristic-person borrower's asset value or annual turnover meets or exceeds the R1 000 000 threshold, or where the parties are not dealing at arm's length. A convertible note to a small startup below that threshold, advanced at arm's length, can fall within the Act, so each note should be checked.
Is a convertible loan debt or equity?
A convertible note is debt until it converts — it is a loan that sits as a liability and, for a note, accrues interest, with cash repayment as a fallback if no round happens. On conversion it becomes equity (shares). A SAFE, by contrast, is structured so it is not classic debt from the outset, which is why it carries no interest or repayment obligation. The instrument's drafting, not its name, decides its character.
Do existing shareholders have to approve a convertible loan conversion?
Sometimes. Section 39 gives existing private-company shareholders a pre-emptive right that must be waived or disapplied before new shares are issued on conversion. Section 41 also requires a 75% special resolution where the convertible securities go to a director or related person, or where the shares issuable on conversion reach 30% or more of the voting power of that class. A shareholders' agreement may add further consents.
Sources & authority
- Companies Act 71 of 2008, ss 38–41 (issue of shares, subscription/pre-emption, consideration, shareholder approval)
- Companies Act 71 of 2008 (full Act — MOI, authorised shares, board issue resolution)
- National Credit Act 34 of 2005, s 4 (application — juristic-person and arm's-length exclusions)
This guide is general information, not legal advice. It reflects the law as at June 2026.