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%