A convertible note is a short-term debt instrument issued to early-stage investors that is designed to convert into equity at a future priced round. It predates the SAFE (2013) and remains common in non-U.S. jurisdictions and for later-stage bridge financings.

How a convertible note works

1. An investor lends the startup money (e.g., $250K).
2. Interest accrues (commonly 4–8% annually).
3. At the next qualified financing (priced round above a threshold, often $1M+), the principal + accrued interest converts into preferred equity at:
   • A discount to that round’s price (usually 10–25%), or
   • A valuation cap (if lower than the round’s pre-money), or
   • Whichever is better for the investor.
4. If no priced round happens before maturity, the terms dictate what occurs.

Key terms

• Principal: The amount lent.
• Interest rate: Annual rate, accrues; converts alongside principal.
• Maturity date: Usually 12–24 months.
• Valuation cap: Max pre-money valuation at which the note converts.
• Discount: Percentage off the priced round’s price.
• Qualified financing threshold: Minimum round size to trigger auto-conversion.
• Change of control: What happens if the company is acquired before conversion (often 1.5–2x principal payout or conversion at cap).

Convertible note vs SAFE

Worked example

• Investor lends $250K with a $10M cap, 20% discount, 5% interest, and 24-month maturity.
• 12 months later, the company raises a $20M pre-money Series A at $1.00/share.
• Accrued interest: ~$12.5K. Total converting balance: ~$262.5K.
• Cap-implied price: $10M / $20M × $1.00 = $0.50/share.
• Discount-implied price: $1.00 × (1 − 0.20) = $0.80/share.
• Investor converts at the better price for them ($0.50), receiving 525,000 shares instead of the ~262,500 a flat conversion would give.

When convertible notes make sense

• Bridge financing between priced rounds (e.g., Series A → Series B bridge).
• International jurisdictions where SAFEs aren’t standard.
• Control over maturity — if you want debt-like investor discipline.

When a SAFE is usually better

• U.S.-based seed rounds with friendly angels.
• Clean cap tables — no interest accumulation, no maturity pressure.
• Faster closes — less negotiation.

Common pitfalls

1. Maturity rollover pressure: Negotiate an auto-extend clause if a priced round is close.
2. Interest stacking: Multi-year notes with 8% interest can meaningfully increase dilution.
3. Ambiguous change-of-control provisions: Always spell out what happens on acquisition before maturity.

Practical takeaway

1. Founders: Use a SAFE unless a note is legally required or you’re doing a structured bridge.
2. Investors: For later-stage bridges, notes’ interest and maturity features protect downside.
3. Operators: Always model cumulative dilution across multiple notes + SAFEs + priced rounds before signing.

Further reading

• YC SAFE vs convertible note guide: https://www.ycombinator.com/documents