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Before the SAFE arrived in 2013, the convertible note was the standard way to raise a seed round without setting a price. It is still common. Founders meet it in bridge rounds between priced financings, with angels who prefer debt and with some investors from outside the Bay Area. Knowing how a note converts can save a founder from an expensive surprise at the Series A.
This page is general information, not legal, tax or financial advice. Note forms vary widely. Small wording changes can move a lot of ownership. Have a startup lawyer review any note before your company issues it.
What a convertible note is
A convertible note is a short-term loan from an investor to a startup. Neither side expects the loan to be repaid in cash. Instead, the principal plus accrued interest turns into shares when the company raises a priced round. Cooley GO describes the instrument as a way to invest before a valuation is set, which can help with cost, speed and raising money on a rolling basis. Its glossary adds that a note converts "often at a discount to the price paid by later investors."
Because it is debt, a note sits ahead of stockholders if the company fails. That legal standing is the main reason some investors prefer notes. Founders sometimes prefer SAFEs for the same reason in reverse: a SAFE carries no repayment obligation at all.
The terms in a typical note
| Term | What it does | What to check |
|---|---|---|
| Principal | The amount invested | Whether notes are issued in one closing or over time |
| Interest rate | Accrues on the principal, usually simple interest | Whether interest converts into stock or must be paid in cash |
| Maturity date | When the loan comes due if it has not converted | What happens then: repayment, conversion or extension |
| Discount | Lets the note convert below the new investors' price | The percentage and whether it stacks with the cap |
| Valuation cap | Sets a maximum valuation for conversion | Which share count the cap is divided by |
| Qualified financing | The round that triggers automatic conversion | The minimum round size in the note |
| Change of control | What holders get if the company is sold first | Repayment, a multiple of principal or conversion at the cap |
| Amendment | How the notes can be changed | Whether a majority of holders can bind everyone |
Most of these terms are set by the company and its lead note investor and then offered to everyone else on the same form. Cooley GO also hosts a document generator that produces a starter set of convertible note documents.
Worked example: a note converts at a Series A
All figures here are hypothetical. An angel lends a startup $1,000,000 on a note with 6 percent simple interest, a 20 percent discount and an $8,000,000 valuation cap. Eighteen months later the company raises a Series A at $2.00 per share, which is a $20,000,000 pre-money valuation on 10,000,000 fully diluted shares.
| Step (hypothetical) | Calculation | Result |
|---|---|---|
| Accrued interest | $1,000,000 x 6% x 1.5 years | $90,000 |
| Amount that converts | Principal plus interest | $1,090,000 |
| Series A price | $20,000,000 / 10,000,000 shares | $2.00 |
| Discount price | $2.00 x 80% | $1.60 |
| Cap price | $8,000,000 / 10,000,000 shares | $0.80 |
| Conversion price | The lower of the two | $0.80 |
| Shares issued to the angel | $1,090,000 / $0.80 | 1,362,500 |
Compare the outcomes. Without the cap the angel would have converted at the $1.60 discount price into 681,250 shares. With no discount or cap at all, $1,090,000 at $2.00 buys 545,000 shares. The cap doubled the angel's share count because the company's value rose well above $8 million before the round.
Two details change these numbers in real deals. First, notes define the share count for the cap differently. Some divide by the pre-money fully diluted count, some exclude the note shares themselves and some include a new option pool. Second, the note converts into Series A preferred, which carries a liquidation preference based on the Series A price. Converting at $0.80 into shares with a $2.00 preference would give the angel a preference worth 2.5 times what it paid. Many Series A charters handle this by issuing a sub-series of preferred to note holders with a preference equal to their conversion price. Ask your lawyer which approach your documents take.
Maturity, repayment and extensions
Every note has a maturity date, often a year or two after issuance. If no qualified financing has happened by then, the note says what comes next. Common choices:
- Automatic conversion into common or preferred stock at a set valuation.
- Holder's choice to convert or demand repayment.
- Extension by agreement of a majority in interest of the note holders.
Demanding cash from a startup that cannot pay rarely helps anyone. Most holders agree to extend instead. Still, a note gives investors leverage at maturity that a SAFE does not. Founders should know where their notes stand at least six months before any maturity date.
Notes versus SAFEs
| Feature | Convertible note | Post-money SAFE |
|---|---|---|
| Legal form | Debt | Contract right to future equity |
| Interest | Yes, usually accruing | None |
| Maturity date | Yes | None |
| Cap measured | Usually against pre-money capitalization | Post-money, including all SAFEs |
| Standard form | Many law firm forms | Y Combinator's published forms |
| Priority if the company fails | Creditor | Behind creditors, ahead of common stock |
The SAFE won the early seed market in Silicon Valley because it is short and standard. Notes remain useful when an investor insists on debt, or when existing investors fund a bridge and want interest for the extra risk. Our SAFE guide walks through the post-money conversion math.
What Palo Alto founders typically ask
Can we raise on notes and SAFEs at the same time?
Yes. Many companies do. Both convert at the priced round, but on different math. Model both together so you can see total dilution before you sign a Series A term sheet. Our cap tables guide shows how to lay this out.
Is a bridge note a bad sign?
Not by itself. Existing investors often fund a bridge to a milestone that supports a higher valuation. What matters is the story behind it. A bridge with harsh terms, such as a large discount plus warrants, may signal that insiders see more risk.
Who should lead a note round?
Usually the largest investor sets the terms and the rest follow on the same form. Seed funds with Peninsula offices, such as Floodgate and Pear VC in Menlo Park, are among the investors founders meet at this stage. Each fund decides its own instruments, so ask what it prefers.
Does a note need a board vote?
Issuing a note is a corporate act that normally needs board approval. Notes are also securities, so the company usually files a federal Form D and any state notices that apply. A lawyer from our startup law firms list can handle both.
Before you sign a note
- Confirm whether interest converts or must be paid in cash.
- Read the maturity clause and the extension mechanism.
- Check the share count behind the cap.
- Ask how the note handles a sale before conversion.
- Make sure every holder signs the same form so the notes can be amended together.
- Add the notes to your cap table model with accrued interest.
Good to know
- Interest on a note increases the investor's shares at conversion, even though no cash changes hands.
- A note's discount and cap usually do not stack. The investor gets whichever gives the lower price.
- For short definitions, see the venture capital glossary.
Frequently asked questions
What is the difference between a convertible note and a SAFE?
A convertible note is debt. It carries an interest rate and a maturity date, so the investor could in principle ask to be repaid. A SAFE is not debt and has neither. Both usually convert into preferred stock at the next priced round using a cap, a discount or both.
What happens when a convertible note matures?
It depends on the note. Some notes convert automatically into stock at a set price at maturity. Others let the holders choose to be repaid or to convert. In practice many holders agree to extend the maturity date instead of demanding cash from a company that may not have it.
Does interest on a convertible note get paid in cash?
Usually not. On most startup notes interest accrues and converts into stock along with the principal. That means the investor ends up with slightly more shares than the original check alone would buy.
What is a qualified financing?
It is the event that triggers automatic conversion, usually a sale of preferred stock above a minimum size set in the note. Cooley GO notes that there may be a minimum size of the financing to trigger automatic conversion. A smaller round might not convert the notes unless holders agree.
Why would a startup choose a note over a SAFE?
Some investors, including some angels and investors outside Silicon Valley, prefer the protection of debt. Notes are also common for bridge rounds from existing investors. Founders sometimes accept a note to close a round faster with investors who will not sign a SAFE.