A short-term debt instrument that converts into equity at a future funding round, typically with a valuation cap and discount rate.
A convertible note is a loan to a startup that is designed to convert into equity rather than be repaid in cash. Investors lend money with the expectation that when the company raises a priced round, the note converts into preferred stock — typically at a favorable price compared to new investors, reflecting the early risk the note holder took.
Key terms in a convertible note: the interest rate (typically 4–8%, which accrues and converts along with the principal), the maturity date (when the note is technically due if it hasn't converted — usually 18–24 months), the valuation cap (the maximum valuation used to convert the note, regardless of how high the actual priced round valuation is), and the discount rate (a percentage reduction in the conversion price compared to new investors).
SAFEs have largely replaced convertible notes for pre-seed funding because SAFEs are simpler and don't create debt on the balance sheet. But convertible notes are still used in some seed financings, and they're occasionally used for bridge rounds (between major funding rounds) when speed is important. If you have a convertible note outstanding as you approach a priced round, the conversion math — which can be complex when there are multiple notes with different terms — needs careful modeling.