Startup Dictionary
Convertible Note
Definition
Short-term debt that converts into equity, typically in conjunction with a future financing round.
Deep Dive
A Convertible Note is a short-term debt instrument commonly used by startups to raise capital from early-stage investors, primarily angel investors or seed funds. Unlike traditional debt, which is repaid with interest, a convertible note is designed to convert into equity (company ownership) at a later financing event, typically a larger, priced equity round (e.g., a Series A). This mechanism allows startups to secure funding quickly and defer the complex process of valuation until the company has achieved more milestones and can command a clearer market price.
Examples & Use Cases
- 1A seed-stage startup raises $500,000 from angel investors through convertible notes, offering a 15% discount and a $5 million valuation cap for conversion in the next round.
- 2An investor provides $100,000 to a pre-revenue company via a convertible note with an 8% interest rate, deferring the valuation discussion until the product launches.
- 3During a Series A round, the outstanding convertible notes automatically convert into preferred stock, with the original investors receiving shares at either the discounted rate or the valuation cap, whichever is more favorable.
Related Terms
Seed FundingEquity FinancingValuation CapDiscount RateSAFE (Simple Agreement for Future Equity)