Convertible note is venture-style bridge debt that automatically converts into preferred stock when a qualified equity financing closes, under pre-negotiated cap and discount terms.

How it works

Standard documents include principal, interest rate, maturity (often 18–24 months), valuation cap, discount (commonly 15–25% off the priced round), and definition of qualified financing minimum size. At conversion, noteholders receive shares at the lower effective price from cap or discount calculations, plus accrued interest converting as additional principal. Change-of-control clauses may force conversion or cash payout. If maturity hits without financing, noteholders can demand repayment—often renegotiated in practice—or leverage for tougher terms. Notes may be senior to equity in liquidation before conversion. Side letters grant pro rata rights in the priced round.

Why it matters

• Founders: Useful when valuation is unsettled, but stacked notes complicate Series A. Lead investors scrutinize note overhang and may require cleanup.
• Investors: Early risk capital with structured upside; legal debt status provides some downside versus SAFEs in insolvency.
• Counsel: Negotiate qualified financing thresholds, most-favored-nation, and whether notes convert on acquisition pre-financing.

Common mistake

Ignoring maturity dates because “everyone extends.” Hostile noteholders or distressed companies face real repayment demands—extensions are not guaranteed.

Related ideas

Convertible debt, SAFE, valuation cap, discount, qualified financing, and bridge round are the core related concepts.