Convertible Note
A short-term debt instrument that converts into equity at a future financing round, usually at a discount. Convertible notes defer valuation negotiations and are common in seed-stage fundraising.
What Is a Convertible Note?
A convertible note is a short-term debt instrument that converts into equity — typically preferred stock — at a future financing round. Instead of setting a valuation today, the note "kicks the can" to the next priced round, where conversion happens automatically. This makes convertible notes faster and cheaper to close than a full equity round.
Key Terms in a Convertible Note
Discount rate: Noteholders typically get a 15-25% discount to the price paid by new investors at the conversion round.
Valuation cap: A ceiling on the conversion price that protects early investors if the company's valuation increases dramatically before the next round.
Interest rate: Convertible notes accrue interest (usually 2-8% annually), which converts into additional shares at conversion.
Maturity date: The date by which the note must convert or be repaid, typically 18-24 months from issuance.
Convertible Note vs. SAFE Note
A SAFE (Simple Agreement for Future Equity) is a simpler alternative created by Y Combinator. Unlike convertible notes, SAFEs have no interest rate, no maturity date, and are not debt instruments. SAFEs are faster to execute and are now more common at the seed stage, while convertible notes are still used when investors want the additional protections of a debt structure.
When Should SaaS Founders Use a Convertible Note?
Convertible notes work best when you need to raise a small amount of capital quickly (under $2M), when setting a valuation would be premature, or when you want to close investors on a rolling basis without coordinating a single close. For founders who want to avoid equity dilution entirely, consider non-dilutive funding options like revenue-based financing instead.
