Convertible Note

A convertible note is a short-term debt instrument that converts into equity at the company's next priced round rather than being repaid in cash. It typically carries four key terms: an interest rate, a maturity date, a conversion discount, and often a valuation cap, combining the speed of a loan with the upside structure of equity. It was the dominant pre-seed and seed instrument from roughly 2005 until 2013, when Y Combinator introduced the SAFE and the market gradually shifted.

The four key terms, with typical 2025 ranges:

Term	Typical range	What it does
Interest rate	4-8% per year	Accrues until conversion; rarely paid in cash
Maturity	18-36 months	Note must convert, be repaid, or be extended by this date
Conversion discount	15-25% (20% common)	Note holder gets the priced-round share price reduced by this %
Valuation cap	$5M-$25M typical at seed	Maximum company valuation at which note converts

How conversion math works at a priced round:

Scenario: $500K note with 20% discount and $8M cap, accrued 18 months of interest at 6%.

Step 1 - Accrued interest: $500K × 6% × 1.5 years = $45K. Total principal + interest at conversion = $545K.

Step 2 - Priced round details: Series A at $20M pre-money, $20.50 per share new issue price.

Step 3 - Note holder's effective price (better of discount or cap):

• Discounted price: $20.50 × (1 - 20%) = $16.40 per share.
• Cap price: $20.50 × ($8M / $20M) = $8.20 per share.
• Note holder gets the cap price ($8.20 per share, which is the better/lower price).

Step 4 - Shares received: $545K / $8.20 = ~66,463 shares.

The cap is doing most of the work in this example. The discount matters more when the priced round is at or near the cap.

Note vs SAFE comparison:

Feature	Convertible note	SAFE
Legal nature	Debt instrument	Not debt; agreement for future equity
Interest	Yes, typically 4-8%	None
Maturity date	Yes, typically 18-36 months	None
Conversion discount	Typical	Less common (post-money SAFEs usually just have cap)
Valuation cap	Common	Standard on most SAFEs
Subordination at bankruptcy	Senior to equity	Pari passu with common equity (worse for investor)
Cap-table complexity	Higher (interest accrual, maturity tracking)	Lower (simpler conversion math)
Default risk	Can trigger default if not converted by maturity	No default mechanism

Why SAFEs won most of the early-stage market:

By 2018, ~80% of pre-seed deals on Carta were SAFEs vs ~15% notes (the rest various). The reasons:

• Simpler: no interest, no maturity, no debt complications.
• Founder-friendly: no default mechanism, no maturity pressure.
• YC standardization: YC moved entirely to SAFEs in 2013, then refined to post-money SAFEs in 2018.

When convertible notes still make sense:

• Bridge financing between priced rounds where investors want senior debt treatment.
• Strategic / corporate investors who prefer debt-like instruments for accounting reasons.
• Specific jurisdictions where debt is preferred over SAFE structures for tax reasons.
• Investors who specifically want a maturity-date lever (some do; many founders don't realize this).

What founders get wrong (specific failure mode): Founder raises $1.5M in convertible notes at pre-seed with 24-month maturity. Eighteen months later, the company hasn't hit Series A metrics, has 8 months of runway left, and the notes mature in 6 months. Note holders are technically entitled to repayment. Founder approaches them for extensions; most agree, but one (now a fund partner who has moved on) says no and demands repayment. The repayment would leave the company with 2 months of runway. Founder ends up extending the cooperative noteholders, paying out the holdout at original principal (eating the interest), and rushing a bridge round on terrible terms. Total cost: weeks of legal work, a $150K cash payout that shouldn't have been necessary, and trust damage with the cooperative investors who absorbed the awkward conversation. The right discipline: use SAFEs unless there's a specific reason; if using notes, model the maturity date concurrent with the planned priced-round timing; have extension language pre-negotiated in the note (not at the maturity date).

Related: SAFE · Valuation Cap · Dilution · Pre-money vs Post-money Valuation · Cap Table · Bridge Round

FAQ

What is the difference between a convertible note and a SAFE?
A convertible note is debt with interest (4-8%) and a maturity date (18-36 months). A SAFE is not debt and has neither. Both convert into equity at a future priced round, usually with a discount and/or valuation cap. SAFEs dominate pre-seed and seed since ~2018; notes still appear in bridge financings and specific situations.

What happens if a convertible note reaches maturity without a priced round?
The note must be repaid in cash, extended by the investor, or converted under default terms specified in the note. In practice, founders renegotiate, but the investor holds the leverage at that moment. Pre-negotiated extension language in the original note is the only protection.

What is a typical discount and interest rate on a convertible note?
20% conversion discount and 4-8% annual interest are typical. Interest accrues and converts into additional shares at the next priced round rather than being paid in cash. Some notes have only a cap (no discount); some have only a discount (no cap); most have both.

When should startups use convertible notes vs SAFEs?
Default to SAFEs for pre-seed and seed (simpler, no maturity pressure, market standard). Use convertible notes for bridge financings where senior debt treatment matters, for strategic/corporate investors with debt-preference, or when specifically wanting a maturity-date mechanism.