TL;DR: A convertible note is a short-term debt instrument that converts into equity at a later date, usually at the company's next priced funding round. It lets startups raise money quickly without setting a valuation upfront, deferring that decision to a future round.
A convertible note is a debt instrument that is intended to convert into equity if a defined event occurs, typically the company’s next qualified priced financing. It has normal debt features, including interest and a maturity date, so if conversion does not occur, the note may become repayable, be extended, or be dealt with under the note’s maturity provisions. In successful startup financings, the expected outcome is usually conversion into shares rather than cash repayment.
Notes usually carry an interest rate and a maturity date, like other debt, plus terms that reward the early investor for their risk: a discount on the next round's price, a valuation cap, or both.
A convertible note is debt, with interest and a maturity date. A SAFE (simple agreement for future equity) is not debt and generally has no interest or maturity. Both convert to equity at a future round and both defer valuation, but the note carries the obligations and protections of a loan, while the SAFE is simpler and more founder-friendly.
A convertible note is a hybrid financing instrument: it starts as debt, with interest and maturity terms, but includes a right or obligation to convert into equity under defined conditions. Convertible notes are common in startup bridge financings, but they are not limited to early-stage companies; mature private and public companies also use convertible debt. Traditional venture debt is usually structured as a repayable loan facility, often with warrants or another limited equity kicker, while a convertible note embeds the equity conversion feature directly in the debt instrument. In practice, the boundary can blur because some venture or growth-debt providers may offer convertible or partially convertible debt structures.
Is a convertible note debt or equity? It begins as debt and is designed to convert into equity. Until conversion, it is a loan with interest and a maturity date.
What is a valuation cap? A ceiling on the valuation at which the note converts. It protects early investors by ensuring they convert at a price no higher than the cap, even if the next round is priced above it.
Related terms: SAFE · Pre-money / Post-money Valuation · Equity Dilution · Bridge Financing
