Convertible Note

A convertible note is a short-term loan to a startup that later converts into equity (shares) when the company raises a future priced equity round.

Core Mechanics

• You lend money now (the principal).
• The company doesn’t repay you in cash; instead, your principal plus interest converts into shares when the next priced round happens.
• The price per share you pay at conversion is usually better than the new investors’ price, via:
  • a conversion discount (e.g., 20% off the next round’s share price), and/or
  • a valuation cap (a maximum valuation used to calculate your conversion price).

Until conversion, the note is legally debt: it has an interest rate and typically a maturity date, and sits ahead of equity in a downside scenario.

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Key Terms

1. Principal Amount
2. Interest Rate
3. Conversion Discount
   • If the new investors pay $1.00 per share, a 20% discount means your conversion price is $0.80 per share.
4. Valuation Cap (optional but common)
   • If the next round is at an $8M valuation but your note has a $4M cap, your effective price per share is based on $4M, not $8M.
   • This often gives you a better price than the discount alone.

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Example Walkthrough

Setup

An angel invests $250,000 in a pre-seed startup via a convertible note with: