Convertible debt is borrowed capital that converts to equity upon specified events—most often a qualified equity financing—rather than repaying principal in cash at maturity.

How it works

Investors fund a note or loan with conversion terms: valuation cap, discount rate, interest (sometimes PIK), maturity date, and change-of-control treatment. On a qualified financing, principal plus accrued interest converts at the better of cap or discount price. If no financing occurs by maturity, parties renegotiate, extend, or face repayment risk unless investors waive. Seniority matters in wind-downs—debt ranks ahead of equity. Multiple stacked notes create cap table complexity at conversion. Convertible debt differs from SAFEs (often equity-like instruments without debt repayment obligation) though both defer pricing.

Why it matters

• Founders: Fast bridge without priced round, but maturity cliffs and investor concentration need planning. Legal review of stacking and pro rata side letters is essential.
• Investors: Downside via debt status pre-conversion; upside via cap/discount. Credit risk if the company stalls before conversion.
• Counsel: Qualified financing definitions, most-favored-nation clauses, and security interests shape closing documents for the priced round.

Common mistake

Raising many uncapped or conflicting notes without modeling conversion dilution—priced round negotiations explode when note holders all convert with different terms.

Related ideas

Convertible note, SAFE, valuation cap, discount, qualified financing, and bridge round are standard related terms.