convertible note
A convertible note is a short-term loan that converts into equity during a future funding round—common in early-stage startup financing.
A convertible note is a funding instrument used in early-stage startups. It starts as a loan—but instead of being repaid in cash, it converts into equity during a future financing round. Investors accept early risk, and in return, they get the right to convert into shares—often at a discount or with a valuation cap.
This tool helps startups raise capital quickly without having to define valuation too early. It delays the pricing conversation until a priced round happens, while still giving early investors equity upside. Convertible notes became popular in seed-stage investing because they reduce friction and speed up execution.
How a convertible note work in real rounds
A startup raises $500K using a convertible note with a 20% discount and a $5M valuation cap. A year later, the company closes a Series A at a $10M valuation. The original noteholders convert their investment into equity at the lower of the cap or with the agreed discount—getting more shares than new investors dollar-for-dollar.
In another case, a founder needs bridge funding before a major round. They issue a note with a 12-month term and 6% interest. The note includes a cap and a discount. If the company fails to raise, the investor may renegotiate—or demand repayment.
What people get wrong about convertible notes
Some founders forget that debt still carries terms—deadlines, interest, and legal obligations. Others ignore how the cap and discount dilute their ownership more than they expect. On the investor side, some assume conversion is automatic, when in fact, specific triggers define when and how it happens.
Another trap: letting notes stack without a strategy. Too many convertible notes across rounds can create messy cap tables, complex negotiations, and valuation headaches later.
Speed is good—until it isn’t
A convertible note can simplify early-stage funding and align incentives when valuation is uncertain. But it’s not free money. It’s a trade: early capital in exchange for future equity—often under terms that favor the investor. Smart founders use notes to buy time and flexibility. Smarter ones do it with a long-term cap table in mind.
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