Convertible Note

Quick Definition

A debt instrument that converts to equity in a future funding round, featuring interest accrual and a maturity date.

What is a Convertible Note?

A convertible note is a loan that converts to equity in a future funding round. Unlike SAFEs, convertible notes are debt instruments with interest rates and maturity dates. If conversion doesn't happen by maturity, the note becomes due.

Convertible notes were the standard early-stage instrument before SAFEs gained popularity. They're still common, especially with angel investors and in certain geographies.

Key Convertible Note Terms

• Principal: The investment amount.
• Interest Rate: Annual interest that accrues and converts with principal.
• Maturity Date: When the note comes due if not converted.
• Valuation Cap: Maximum conversion valuation.
• Discount: Percentage reduction from Series A price.

Conversion Triggers

Notes typically convert upon a "qualified financing" (usually defined as raising above a threshold, like $1M). If conversion doesn't happen by maturity, the company must repay or renegotiate.

Notes vs SAFEs

• Notes are debt with maturity risk.
• SAFEs have no maturity.
• Notes accrue interest.
• SAFEs don't.
• Notes may be preferred by investors wanting more protection.
• SAFEs are simpler and more founder-friendly.

Formula

• Amount at Conversion = Principal + Accrued Interest
• Conversion Price = Lower of (Cap Price) or (Qualified Price × (1 - Discount))

Example

$250K convertible note terms:

• Interest rate: 6% annual
• Maturity: 24 months
• Valuation cap: $4M
• Discount: 20%

After 18 months, Series A at $8M pre-money:

• Principal + interest = $250K + $22.5K = $272.5K
• Converts at $4M cap (better than $8M × 0.8 = $6.4M)
• Ownership = $272.5K ÷ $4M = 6.8%

Related Terms

• SAFE (Simple Agreement for Future Equity)
  An investment agreement that converts to equity in a future funding round, featuring a valuation cap and/or discount without debt terms.
  Learn more

• Valuation Cap
  The maximum valuation at which a SAFE or convertible note converts to equity, protecting early investors from excessive dilution.
  Learn more

• Discount Rate (SAFE/Note)
  A percentage reduction on the next round's share price for SAFE or convertible note holders, rewarding early risk.
  Learn more

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