Business
Convertible Notes Explained
Learn about convertible notes, a popular funding tool for startups. Understand how this short-term debt converts into equity for early investors.
What is it?
A convertible note is a short-term loan used by startups to raise seed funding. Instead of being repaid, the debt "converts" into equity (ownership) during a future financing round. This allows a startup to secure money without setting a formal company valuation, which is difficult for a new venture. Key terms include a "valuation cap" that sets the maximum conversion price and a "discount" that gives early investors a lower share price as a reward for their risk.
Why is it trending?
Convertible notes are popular for their speed and simplicity. They are faster and less legally complex than traditional equity rounds, helping founders secure cash quickly. By deferring the difficult valuation debate, founders and investors can focus on building the business. This efficiency makes them a go-to tool for angel investors and seed funds to deploy capital into promising startups, bridging the gap to a larger, priced funding round like a Series A.
How does it affect people?
For founders, notes provide critical early capital but risk future ownership dilution. For investors, they offer a way to get into a company with favorable terms that reward their early belief. When the company grows and raises more money, the investor’s loan becomes an ownership stake, aligning their financial interests directly with the startup’s long-term growth. This shared incentive is foundational to many early-stage founder-investor relationships.