Raising your first round of capital is stressful enough without also trying to guess what your company is worth. That's the whole point of a Convertible Note. It lets you take money now and figure out the valuation later, when you actually have something to point to. Below, we'll walk through what a convertible note is, how convertible notes work in practice, and where they land next to SAFEs, with a few real convertible note examples thrown in.
Put simply, a convertible note is a loan. But it's a loan that's never really meant to be repaid in cash. Instead, it converts into shares of the company once a bigger, priced round comes along.
So what is a convertible note actually for? Mostly, it buys founders time. Pricing a company in its earliest days is guesswork at best, and notes let you sidestep that guesswork for a while.
Every note comes with three basics: a principal amount, an interest rate, and a maturity date. Most mature somewhere between 12 and 24 months after signing, though that varies.
If the company closes a qualifying equity round before then, the note usually converts on its own. If it doesn't, things get more complicated, and founders end up negotiating repayment, an extension, or conversion on new terms.
If you want to understand how convertible notes work, two terms matter more than anything else: the valuation cap and the discount rate. Both exist to reward investors for taking a risk before anyone else would.
The cap sets a ceiling on the valuation used to price the note's conversion. Say the next round comes in higher than that cap. The noteholder still converts as if the company were worth the capped amount.
In practice, that means early backers walk away with more shares per dollar than the investors who show up later. It's their reward for believing in you when the outcome was far from certain.
A discount rate works differently, but the goal is the same. It just knocks a percentage off whatever price new investors are paying. A 20% discount means someone pays $0.80 for a share that costs new investors a full dollar.
A lot of notes carry both a cap and a discount. When that's the case, the investor typically gets whichever number benefits them more at conversion.
Interest quietly builds up over the life of the note and gets added to the principal at conversion. Maturity dates add pressure of their own. Miss that date without a qualifying round, and you're back at the negotiating table.
Here's a simplified breakdown of how a cap plays out at conversion:
| Scenario | Round Valuation | Note Cap | Investor's Price vs. Round Price | Shares per Dollar |
| No cap | $20 million | None | Same price | 1x |
| Moderate cap | $20 million | $10 million | About 50% lower | About 2x |
| Aggressive cap | $20 million | $5 million | About 75% lower | About 4x |
It's a small table, but it tells you almost everything about why the cap deserves your attention.
Convertible Notes vs. SAFEs comes up in nearly every early fundraising conversation, and for good reason. Both delay setting a price, but they don't work the same way underneath.
A SAFE isn't debt at all, despite feeling similar on the surface. There's no interest, no maturity date, and none of the repayment pressure that comes baked into a note.
| Feature | Convertible Note | SAFE |
| Legal structure | Debt that converts to equity | Contract for future equity |
| Interest | Yes | No |
| Maturity date | Yes, typically 12 to 24 months | No |
| Repayment risk | Yes, if not converted | No repayment obligation |
| Legal complexity | Moderate to high | Low to moderate |
Founders raising a very early, pre-product round often lean toward SAFEs, mostly for the speed. Notes tend to make more sense once a priced round feels close and investors want that extra debt-style protection.
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Numbers help more than definitions here, so let's walk through a couple of convertible note examples. Say a startup raises $500,000 on a note with a $5 million cap and no discount attached.
A year later, that company closes a Series A at a $20 million valuation. Because of the cap, the earlier investor still converts as though the company was only worth $5 million.
Do the math, and that investor ends up with roughly four times the shares a new Series A backer gets for the same check size. That's the real cost founders need to weigh going in.
Plenty of notes combine a cap with a discount, say 20%. At conversion, the investor takes whichever price works out lower for them, the capped price or the discounted one.
Don't treat every note as boilerplate you can skim and sign. Small differences between notes add up fast once you've got more than one sitting on your cap table.
Keeping these terms consistent across every note you raise will save you a lot of pain later.
Notes feel painless when you sign them, which is exactly what makes them tricky. The dilution doesn't disappear; it just waits quietly until conversion.
Raise several notes with different caps and discounts, and you'll end up with a cap table that's genuinely hard to untangle. Future investors will want to model every single one before they hand you a term sheet.
Maturity dates cause their own headaches too. If you don't have a qualifying round lined up in time, you may find yourself negotiating from a much weaker position than you'd like.
The fix is boring but effective: model your dilution early, long before any note is close to maturing.
Notes aren't always the right call, and that's worth saying plainly. If your startup already has real traction, a priced round might actually leave you better off long term.
Priced rounds set ownership the moment they close. Yes, they take more legal work upfront, but you avoid the deferred pricing puzzle that notes eventually hand you.
SAFEs, meanwhile, still make the most sense for the earliest, simplest raises where speed beats structure every time. Which option fits really comes down to your stage, what investors expect, and how soon a priced round is realistically on the table.
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It's essentially a loan from an investor that converts into company shares later, usually at a future funding round, rather than being repaid in cash like typical startup debt.
Founders and investors have to sit down and negotiate. That usually means repaying the note, pushing the maturity date out, or converting it under whatever fallback terms were written in.
SAFEs suit very early, pre-revenue startups that want speed above all else. Notes make more sense once a priced round feels near, since investors get interest and maturity protections.
Definitely, that's actually pretty common. At conversion, the investor gets whichever term favors them more, either the capped valuation or the standard percentage discount, whichever is lower.
Not immediately, no. Dilution only kicks in once the note converts, not at signing. That said, too many poorly structured notes can quietly eat into founder equity over time.
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