Deal Terms
What is a convertible note?
Quick Answer
A convertible note is a short-term debt instrument that converts into equity at the next priced round, typically with a valuation cap, discount rate, interest rate (2-8%), and maturity date (12-24 months).
Detailed Answer
A convertible note is a loan that converts to equity instead of being repaid. Before SAFEs became dominant, convertible notes were the standard early-stage investment instrument.
Key terms: - **Principal** — The investment amount - **Interest Rate** — Typically 2-8% per year (accrues and converts to equity) - **Maturity Date** — When the note comes due (12-24 months). If no conversion event occurs, the company must either repay or negotiate an extension. - **Valuation Cap** — Maximum valuation for conversion (like a SAFE) - **Discount Rate** — Typically 15-25% discount to next round price
Conversion trigger: A qualified financing (typically $1M+ equity round) automatically converts the note principal + accrued interest into shares at the lower of: - Valuation cap price per share - Discounted price per share
Key differences from SAFEs: - Convertible notes ARE debt (SAFEs are not) - Notes have interest rates and maturity dates - Notes create legal obligation to repay - Notes are slightly more complex legally
Trend: SAFEs have largely replaced convertible notes for seed-stage deals in Silicon Valley, though convertible notes remain common outside the Bay Area and in international markets.
Related Questions
What is a SAFE (Simple Agreement for Future Equity)?
A SAFE is an investment contract created by Y Combinator where an investor provides capital to a startup in exchange for the right to receive equity in a future priced round, with terms like a valuation cap and/or discount rate.
What is a term sheet?
A term sheet is a non-binding document that outlines the key terms and conditions of a proposed investment, including valuation, investment amount, board seats, liquidation preferences, and protective provisions.
What is a liquidation preference?
A liquidation preference gives preferred shareholders (investors) the right to receive their investment back before common shareholders in an exit. The standard is 1x non-participating, meaning investors get back their investment amount or convert to common stock — whichever is higher.
What is anti-dilution protection?
Anti-dilution protection adjusts an investor's conversion price downward if the company raises a future round at a lower valuation (down round). The standard type is broad-based weighted average, which partially protects investors while limiting founder dilution.
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