Convertible Note
Definition
A short-term debt instrument that converts into equity (usually preferred stock) at a future financing round. Unlike SAFEs, convertible notes have an interest rate, a maturity date, and create actual debt for the company. They typically include a conversion discount and/or valuation cap.
Real-World Example
An investor lends $200K via a convertible note with 5% annual interest, a $10M cap, and a 20% discount. At the Series A priced at $15M, the note converts. The investor gets the better of: converting at the $10M cap (giving them 50% more shares) or converting at a 20% discount to the Series A price.
Common Mistake
Ignoring the maturity date. If the company does not raise a priced round before the note matures, the investor can demand repayment of the loan. This can create a cash crisis. As a potential employee, outstanding convertible notes nearing maturity are a red flag.
Why It Matters
Like SAFEs, convertible notes represent hidden dilution that is not on the current cap table. They also create real debt obligations. Understanding outstanding notes helps you assess both your future dilution and the company's financial health.
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