October 26, 2026
A convertible note is a loan to your startup that converts into preferred stock at your next priced round, usually at a discount or a valuation cap, whichever gives the investor more shares. Because it's debt, it accrues interest and has a maturity date. For most pre-seed rounds a post-money SAFE is simpler, but a note still makes sense when an investor insists on debt, the company is an LLC, or you're raising a short bridge to a round that's already in sight.
Key takeaways
A convertible note is a promissory note (debt) with one extra feature: instead of being repaid in cash, it converts into shares when the company raises a priced round. Until then, the investor is a creditor, not a stockholder.
Notes were the standard early-stage instrument before the SAFE. Today the post-money SAFE is the default, and notes are the exception. See SAFE vs. Convertible Note vs. Priced Round.
A note is the better tool in a few situations. The company is an LLC, and a standard SAFE assumes a corporation with preferred stock. An investor, often an angel, family office or non-US investor, wants to hold debt rather than a contract right. Or you're raising a short bridge to a priced round that's already underway, and a maturity date won't put pressure on the company. Outside those cases, a SAFE is shorter, cheaper to paper and easier to explain to your next investor.
Usually a short term sheet, the note itself, and often a note purchase agreement that holds the company's representations and the administrative terms, including how the notes can be amended. Some rounds put everything in the note. The board approves the form of note and the maximum amount to be raised.
Notes can close on a rolling basis, so you can take each investor's money as soon as they sign. Setting one or two closing dates gives undecided investors a deadline.
Principal and interest. The principal is the amount loaned. Interest is usually simple, not compounding, and today commonly runs about 6% to 8% a year. Seed investors don't invest for the interest. It mostly increases the number of shares they get on conversion.
Maturity date. The date the principal and interest come due, typically 18 to 24 months after issuance. Set it comfortably after the date you expect to raise your next round. If you plan to raise in 18 months, a 24-month maturity gives you room.
Qualified financing. The notes convert automatically when the company closes a priced round of preferred stock that raises at least a minimum amount of new money, not counting the notes themselves. Set the threshold relative to what you're raising on notes, often one to two times the total principal. Too low, and investors worry the notes could convert at the cap in a token round. Too high, and a real round might not trigger conversion (see below). Note holders receive the same preferred stock as the new investors, with the same rights except that their liquidation preference should be based on what they paid (more below, and in Valuation Cap and Liquidation Preference), so when you negotiate the round's terms you're setting them for your note holders too.
Discount. The note converts at a discount to the price new investors pay, usually 20%.
Valuation cap. The cap sets a maximum price for conversion. If the round's valuation is above the cap, the note converts as if the valuation were the cap. A note cap is usually measured pre-money, unlike a post-money SAFE. See Valuation Cap.
Security. Early-stage notes should be unsecured, meaning the noteholders have no lien on the company's assets. If an investor asks for a security interest, push back and talk to your lawyer before you agree. If you also borrow from a bank or venture lender, that lender will almost always be secured and paid first, and its loan agreement may require your noteholders to subordinate their notes.
Extras. Larger note investors sometimes ask for pro rata rights in the next round, or a small warrant as a sweetener. Pro rata for a meaningful check is reasonable. A warrant is extra equity on top of the discount or cap, so price it into the deal. See Pro Rata Rights and Stock Warrants.
The investor gets the better of the discount or the cap. Here's an example.
An investor buys a $500,000 note with a 20% discount and a $5,000,000 pre-money cap. A year later, the company raises a Series Seed at a $10,000,000 pre-money valuation, with 10,000,000 shares on a fully diluted basis, so new investors pay $1.00 per share.
The cap price is lower, so the cap wins. If the note accrued 6% simple interest for one year, $530,000 converts at $0.50, and the investor receives 1,060,000 shares of Series Seed preferred. With the discount alone, the same $530,000 would buy only 662,500 shares.
This is simplified. Real notes define the cap price by reference to a specific share count, and that definition can move the result. Model it before you sign.
They can, if the note converts into exactly the same preferred stock as the new money. In the example above, the note holder converts $530,000 at the $0.50 cap price and receives 1,060,000 shares, while the new investors pay $1.00 a share. If every one of those shares carries the new investors' $1.00 liquidation preference, the note holder has $1,060,000 of preference for $530,000 of principal and interest. The cap price is half the round price, so the preference doubles. The extra $530,000 is called liquidation overhang, and it grows as the round price moves further above the cap.
Overhang matters when a sale doesn't make everyone rich. With a standard 1x non-participating preference, each holder takes either its preference or its share as common, whichever is more. With the full $1.00 preference, the note holder would take $1,060,000 off the top in any sale where a share of common is worth less than $1.00. That money comes out of what the common stock would otherwise receive and, if the sale doesn't cover every preference, out of the new investors' share too.
The fix is a shadow series. A note that converts below the round price should convert into a sub-series of the new preferred, such as Series Seed-1, that's identical to the new investors' stock except that its liquidation preference and its starting price for anti-dilution are based on the note holder's conversion price. In the example that's $0.50 a share, so the 1,060,000 shares carry $530,000 of preference, matching the principal and interest that converted. The holder keeps every share, every vote and all of the upside. Only the size of the preference changes.
The YC post-money SAFE builds this in. Many notes don't. They simply convert into the shares sold in the round. Ask for shadow series language when you sign the notes. If notes you've already issued lack it, raise it before you sign the priced round's term sheet. The note's amendment clause sets whose consent you need, and a new lead investor has reason to support the change, since overhang also comes out of its share in a weak sale. See Liquidation Preference.
Most notes have no monthly payments. Principal and interest are all due at maturity. Some notes let the company or the holders convert at maturity at the cap or another agreed price. If the note doesn't say that and the company hasn't raised, the investor can technically demand repayment, which most startups can't afford.
In practice, investors rarely force repayment. The usual answer is an extension.
Most note purchase agreements let the company amend all the notes in a series with the consent of holders of a majority of the outstanding principal. To extend maturity, the board approves a short amendment, and the majority holders sign it, before the maturity date passes. Every note in the series is then extended, including those held by investors who didn't sign. Check your documents, because some notes require each holder's consent for changes to economic terms.
If you've issued several series of notes with different maturity dates or conversion terms, one omnibus amendment can align them. It needs approval from the required majority of each series.
Usually not. The standard qualified financing definition requires a sale of preferred stock at a fixed valuation, and a SAFE round isn't one. Your notes keep accruing interest and keep their maturity date. If you want them to convert alongside the SAFEs or into a later round on different terms, amend them.
The notes don't convert automatically. Some notes give the holders an option to convert in a smaller round, but the choice is theirs, not yours. New investors will almost always insist that every note converts at closing, so they aren't investing behind outstanding debt.
That means you need noteholder consent to amend the notes, usually to lower the threshold or to convert them in this round. This is where the amendment clause matters. If holders of a majority of the principal can amend every note, you need a handful of signatures. If each holder must consent, one holdout can stall the closing. Start these conversations before you sign the term sheet.
They still count. An outstanding note is debt that will convert in your priced round, and investors will find it in diligence. Track every note on a separate convertibles tab of your cap table, not as issued shares, with its issue date, principal, interest rate, accrued interest, discount, cap and maturity date. Then decide before the round whether it will convert, be repaid or be amended. See What Is a Cap Table?
Yes. A founder loan can be documented as a convertible note on the same terms as an outside investor's, with board approval and the founder abstaining as an interested director. Use real terms: a market interest rate and a cap consistent with the rest of your round. A below-market or interest-free loan to your own company can create tax issues, so talk to a tax advisor about the rate.
The note says. Most give the holder a choice: repayment of principal and interest plus a premium, often a multiple of the principal (commonly 1.5x to 2x), or conversion into common stock at the cap so the holder shares in the sale proceeds. Negotiate this term at the start, because it's hard to change once a buyer is at the table.
Go deeper: For a full walkthrough, see our Founder Guide to Convertible Notes and Founder Guide to SAFEs.
For more, see SAFE and What Comes After Fundraising? If you'd like help with a note round or a note amendment, see our convertible note services or contact us.
