A convertible note is a type of debt that can be converted into equity at a later date, usually at the discretion of the lender or under certain predetermined conditions. Convertible notes are often used in early stage financing for startups, where the value of the company may be uncertain and a traditional equity investment may not be feasible.
In a convertible note financing round, the investor loans money to the company and receives a promissory note that states the terms of the loan, including the interest rate and maturity date. The note also includes a conversion clause that allows the investor to convert the debt into equity at a later date, often at a discount to the company’s valuation at the time of conversion.
Convertible notes are attractive to early stage investors because they offer the potential for a higher return on investment if the company’s valuation increases significantly over time. They are also attractive to startups because they can delay the need to determine a valuation for the company, which can be difficult to do at an early stage. However, convertible notes also carry some risk for the investor, as there is no guarantee that the company will be successful and the debt may not be paid back.