In recent years, the proliferation of startup funding instruments such as SAFEs, convertible notes and other structured-debt rounds has quietly ushered in a wave of what one might call “phantom valuations.” Under the veneer of impressive round sizes and lofty paper valuations, the reality of what a company is truly worth — or will eventually be worth — has become increasingly opaque. For seasoned venture capitalists, business angels, and founders alike, mastering a critical eye toward these funding mechanisms is no longer optional: it is essential.

The debate — echoed across Reddit threads, expert forums and industry commentary — hinges on a burning question: are the valuations we see still credible, or is the system being gamed by financial engineering rather than genuine business fundamentals?

This article unpacks how SAFEs and convertible notes can inflate valuations in misleading ways, illustrates real-world examples from the current European funding environment, and offers guidance for investors and founders navigating this complex terrain.

I. The Mechanics: Why SAFEs & Convertible Notes Enable Phantom Valuations

At first glance, instruments like the Simple Agreement for Future Equity (SAFE) or a Convertible Note appear as elegant, founder-friendly shortcuts: they allow startups to raise capital quickly, without the friction, cost, or time of a full priced equity round.  

In a priced round, the company valuation (pre-money and post-money) is spelled out explicitly, and investors know exactly what percentage of the company they are receiving for their money. SAFEs and convertible notes, by contrast, postpone that valuation until a “trigger event” — often the next equity round.  

These instruments typically include provisions such as a “valuation cap” or a “discount,” which determine at what valuation the debt will convert into equity. For instance, a SAFE may be capped at $10 million, even if the next priced round occurs at $25–30 million. In that case, early investors convert as if the company were worth $10 million — thereby securing a larger share than their cash alone might warrant.  

In practice, this means a startup can raise substantial cash without ever “resetting” or publicly revealing a realistic valuation. On paper, the company appears well-valued and well-funded — but until a priced round occurs (if ever), the nominal valuation may remain more an aspiration or hope than a reflection of actual enterprise value.

Convertible notes add further complexity. As debt instruments, they often accrue interest until conversion, swelling the amount owed and increasing dilution upon conversion.  

Moreover, convertible notes carry maturity dates: if a proper priced round does not occur by then, investors may demand repayment, or — if conversion happens at a lower valuation — founders and early shareholders may be severely diluted.  

In short: these instruments postpone valuation, obscure real ownership stakes, and often lead to bigger dilution than initially apparent. That’s why many refer to the resulting valuations as “phantom”: numbers that look good on paper — yet may evaporate or drastically recalibrate when transparency finally arrives.

II. Market Trends & Real-World Examples: The Recent Surge in Structured Debt Deals

This theoretical risk is not abstract — it has become a tangible feature of today’s startup funding landscape, especially in Europe. According to recent data, 2023 saw a record $2.5 billion in convertible-debt issuance by European venture-backed firms, up from $1.7 billion in 2022.  

Lawyers, founders and investors interviewed in the press warn that the deals have become more “structured,” with protective clauses that favour investors: better conversion terms, larger equity stakes triggered if financial or operational milestones are missed, or enhanced rights tied to future IPO or fundraising delays.  

This trend coincides with broader macro shifts: as venture capital funding slows, many startups are reluctant to accept lower valuations in a down market. Instead, they turn to convertible debt or SAFEs to raise new capital — thereby deferring the need to reprice their company downward.  

In effect, what you get is a “patchwork financing” — multiple convertible rounds, bridges, extensions — each potentially layered with its own caps, discounts and terms. On paper, the company may look like it’s raised several tens of millions; but actual shareholder dilution and conversion conditions may tell a very different story once the next priced equity round happens (if it does).

This structure can create two major distortions. On one hand, it perpetuates inflated nominal valuations and headline-making numbers for media or marketing purposes. On the other, it injects uncertainty — and risk — for all stakeholders: early shareholders, employees with option pools, future investors, and even the founders themselves.

Some in the ecosystem have begun to sound the alarm. As one experienced counsel put it, “if you don’t know what you’re doing, structured debt can be a Trojan horse.” 

III. Misaligned Incentives: Why Convertible Instruments Might Favor Some — and Hurt Others

The use of SAFEs and convertible notes changes the incentive dynamics between founders and investors. With a priced round, investors and founders align: both seek to maximize company valuation, because it determines ownership percentages.

With convertible debt, however, the dynamic can invert. As pointed out in commentary from industry practitioners, note-holders often benefit more from a lower future valuation (since conversion occurs at the cap or discounted price); conversely, founders benefit from a higher valuation. Hence, there can be a structural misalignment of interests.  

This misalignment can produce unintended — even adverse — effects. For example, convertible-note holders may pressure for a quicker — but lower-valued — priced round, in order to maximize their equity stake. Or, they may push for terms that disadvantage employees’ option pools or future investors. The result can be a cap-table structure that rewards early convertible investors disproportionately, at the expense of long-term equity fairness.

Founders, on their side, often accept SAFEs and convertible notes to gain speed and simplicity. But many underestimate the “stacking effect”: multiple SAFE or note rounds — each with its own cap, discount, interest accrual — that convert all at once. The dilution impact is frequently far greater than what founders anticipated at the outset.  

And because SAFEs often lack maturity dates or other forced conversion triggers, these layers can accumulate over time — sometimes indefinitely — delaying the moment of truth when cap tables are finally cleansed and real valuations emerge.  

In effect: what outsiders — press, media, even some investors — perceive as a strong “valuation story” may, under the hood, be a fragile tower built on deferred dilution, deferred conversion, and deferred reckoning.

Conclusion: Navigating the Ecosystem with Eyes Open — Advice for Investors and Founders

In today’s environment, where capital scarcity meets funding urgency, SAFEs and convertible notes are understandable tools. They provide liquidity quickly, defer complex negotiations, and (on face value) help preserve lofty valuations. But they also carry real risks — for transparency, alignment, and ultimately for sustainable value creation over time.

For investors, the red flag should not be a large cheque or a high “valuation cap,” but rather a lack of clarity about conversion mechanics, future dilution, and ownership dynamics. It is essential to demand — and model — the fully diluted cap table post-conversion, including accrued interests, discounts, option-pool effects, and any protective clauses. Ask what the “real” percentage ownership will be under different exit or financing scenarios.

For founders, it is imperative to treat SAFEs and convertible notes not as “free money,” but as deferred equity rounds. Negotiate caps, discounts, and triggers carefully. Limit the number of stacked convertible securities. Consider potential dilution not only for yourself, but for employees, early investors, and future shareholders. And if possible, plan for a priced round sooner rather than later to establish a more stable and transparent cap-table.

Ultimately, skepticism — the kind you apply to a prospective investment — should also apply to headline valuations. In a world where structured financing can create alluring but fragile “phantom valuations,” the real value lies not in the numbers on the term sheet, but in the clarity, alignment, and future reality those numbers will eventually reflect.

For the ecosystem to remain credible, responsible and sustainable, both founders and investors must read between the lines — and invest with eyes wide open.