Software Growth

Convertible note

A convertible note is a short-term loan that converts into equity at a later funding round instead of being repaid in cash, usually with a discount or cap.

A convertible note is debt that is meant to turn into equity. An investor lends you money, interest accrues, and when you raise a priced round (called a qualified financing) the principal and interest convert into shares, usually at a better price than the new investors get. It became the standard early-stage instrument before the SAFE and is still common, especially outside the YC world.

Key terms

  • Interest rate. Often a few percent a year, accruing as simple interest. Interest adds to the amount that converts.
  • Maturity date. The date the note falls due if no round has happened, often 12 to 36 months out.
  • Discount. A reduced price versus the next round's investors.
  • Valuation cap. A ceiling on the valuation used for conversion.

Summaries of current practice, such as this overview of note terms, put typical interest at roughly 4 to 8 percent and the discount at 10 to 30 percent. Treat those as ranges, not rules; each deal is negotiated.

How conversion works

Say you take a $100,000 note at 6 percent simple interest, and the note converts after 18 months. Interest is 100,000 x 0.06 x 1.5 = $9,000, so $109,000 converts. If the Series A price is $1.00 per share and the note has a 20 percent discount, it converts at $0.80, giving 109,000 / 0.80 = 136,250 shares.

How it differs from a SAFE

The core difference is that a note is debt and a SAFE is not. A note carries interest and a maturity date, which means in principle the investor can ask for repayment or negotiate an extension if no round arrives. A SAFE has neither. Notes also usually need more legal work, and so cost more to set up. People who favor notes, such as this lawyer's comparison, point to founder-protective terms available in a negotiated note. Both instruments push dilution into the future, so model them in your cap table before you sign.

For small SaaS

If you may never raise a priced round, a note's maturity date matters: you could owe repayment on a date set by the contract. Read what happens at maturity before you sign. This is general information, not legal advice.

Sources

Back to the SaaS glossary