Convertible Note
What is Convertible Note?
A convertible note is a hybrid between a loan and equity. You borrow money (principal) with an interest rate and maturity date (usually 2 years). When a Series A happens, the note converts into Series A stock at a discount (typically 20-30%) or at a valuation cap, whichever is better for the investor. If Series A never happens, the note technically comes due as a loan. Convertible notes are common at seed stage but less popular now because SAFEs offer a simpler alternative.
Why It Matters
Convertible notes give seed investors some downside protection (interest accumulation, maturity date forcing a outcome) while deferring valuation. For founders, the main risk is that the interest rate and valuation cap create complexity, and having a maturity date hanging over your head adds pressure. If you don't raise Series A by maturity, you legally owe the principal back (which most seed-stage startups can't do), creating leverage against you. Notes are less founder-friendly than SAFEs but more investor-protective.
How to Apply
If you use convertible notes, establish clear terms upfront: principal amount, interest rate (typically 5-10% annual), maturity date (24 months), valuation cap, and discount. Valuation cap protects early investors—if you raise Series A at $10M post-money and early investors have a $3M cap, they convert as if the Series A valuation was capped at $3M, giving them a bigger discount. Interest accrues monthly but typically only adds to the conversion amount; you don't pay cash interest. Keep notes simple and consistent—use the SAFE or a standardized convertible note template to avoid custom legal chaos. Model the dilution impact during Series A (interest owed gets converted to equity, further diluting founders). Be mindful of the maturity date creeping up; if you're likely to miss it, negotiate an extension before it becomes a crisis.
Common Mistakes
- Setting a valuation cap too low in an effort to attract investors, then facing massive dilution when Series A converts at below-market terms
- Issuing too many convertible notes at different terms, creating complexity that slows Series A diligence and confuses your cap table
- Ignoring the maturity date and approaching it unprepared; late-stage startups sometimes resort to messy extensions or amendments to avoid default
How IdeaFuel Helps
IdeaFuel's Business Plan Generator models convertible note scenarios and their dilution impact at Series A, helping you choose between Notes and SAFEs based on realistic fundraising timelines.