A convertible note is a short-term debt instrument that can be converted into equity in a company. It is commonly used by startups during early-stage funding rounds because it allows them to raise capital without immediately determining a valuation.
Key Features of Convertible Notes
- Debt with Conversion Option – Investors lend money to a startup, and instead of receiving repayment, they can convert the debt into shares.
- Valuation Flexibility – The startup does not need to set a valuation at the time of investment.
- Discount Rate & Valuation Cap – Investors may receive a discount or a cap on the valuation when converting their debt into equity.
- Interest Accrual – Convertible notes often accrue interest, which is added to the principal amount upon conversion.
How It Works
- Investor provides funding to the startup in exchange for a convertible note.
- The note accrues interest and has a maturity date (typically 18-24 months).
- Conversion into equity happens when a triggering event occurs, such as a future funding round or an acquisition.
- Investors may receive benefits like a discount rate or valuation cap when converting their debt into shares.
Would you like to explore how convertible notes compare to other startup funding options?