Convertible notes explained. Debt that becomes equity.
Convertible notes were the dominant early-stage instrument before SAFEs took over around 2018. They still appear in many situations: investors unfamiliar with SAFEs, situations requiring debt structure, friends-and-family rounds, and certain international contexts. This guide explains how they work, the key terms, the difference from SAFEs, and the conversion math at the next priced round.
Start here.
Convertible note is a loan. Investor lends money to the company; note has interest and maturity date.
Typically 4-8% annual interest, accrued (added to principal at conversion). Not paid as cash interest.
Typically 18-36 months. At maturity, must convert, be repaid, or extended. Negotiation point if no priced round before maturity.
At next priced round, principal + accrued interest convert to preferred stock at the lower of (a) cap valuation or (b) next-round price × (1 - discount).
Convertible notes are debt (interest, maturity). SAFEs are not debt (no interest, no maturity). Otherwise similar conversion mechanics.
The full picture.
What a convertible note is
A short-term loan from investor to company that converts to equity at the next priced round. Until conversion, it is a debt obligation: company owes the principal + accrued interest. After conversion, it is preferred stock.
Key terms
Principal: the loan amount. Interest rate: typically 4-8% annual, accrued. Maturity date: typically 18-36 months from issuance. Valuation cap: max valuation at conversion. Discount: percentage off next-round price. Most-Favored-Nation: protection if you issue later notes on better terms. Pro-rata rights: option to participate in future rounds.
Interest accrual
Interest accrues over time, added to the principal. At conversion, the total (principal + accrued interest) converts to equity. A $500k note at 6% accruing for 18 months: principal $500k + interest ~$45k = $545k converts.
Maturity considerations
At maturity, three options: (1) Triggered conversion: most notes convert if a priced round has happened. (2) Repayment: company must repay (rare in practice; companies often cannot afford it). (3) Extension: investor and company agree to extend maturity. Some notes auto-convert to equity at a default rate if maturity arrives without a priced round.
Conversion mechanics
Same as SAFE: conversion at lower of (a) cap valuation or (b) next-round valuation × (1 - discount). Result: investor gets more shares than if they bought at next-round price.
When to use convertible notes
Friends-and-family rounds where investors prefer "loan" framing. International contexts where SAFE legal structure is unclear. Investors who specifically request convertible notes. When you want a forcing function (maturity date) to push toward a priced round.
When to use SAFE instead
Most US pre-seed and seed rounds. Speed and simplicity priority. No appetite for the maturity-date complication.
Common pitfalls
(a) Maturity without conversion: if no priced round happens, you face a debt obligation or extension negotiation. (b) Stacking too many notes: multiple convertible notes with different terms create messy conversion math. (c) Discount + cap interaction: many founders do not understand that they are giving investors the BETTER deal at conversion, not both.
Worked example: $500k convertible note, 6% interest, 18 months to conversion
| Note signed: $500k principal at 6% interest | Loan begins |
| After 18 months (next priced round) | Principal: $500k + Accrued interest: $45k = $545k |
| Note terms: $5M cap, 20% discount | Whichever gives more shares |
| Next round at $10M pre / $12M post | Cap rate is lower than 80% × $10M = $8M; cap wins. |
| Conversion price | $545k / ($5M / 10M shares pre) = ~1.09M shares. |
| Series A investor at $10M | $2M / $12M = 16.7% |
| Note holder owns ~10%; Series A 17%; founder/team dilute proportionally |
Common questions.
What is the main difference between a convertible note and a SAFE?
What happens if my note reaches maturity without a priced round?
What is the typical interest rate?
Can convertible notes be repaid in cash instead of converting?
Do convertible notes have voting rights?
What is the discount typically?
Should friends and family invest via convertible note or SAFE?
Are convertible notes considered debt on the cap table?
Can I have both SAFEs and convertible notes outstanding?
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