Convertible Note
A convertible note is a debt instrument used in early-stage venture that converts into equity at a future priced round, typically with a valuation cap and/or discount, plus interest and a maturity date. Allocators evaluate notes because maturity pressure, conversion triggers, and restructuring behavior materially influence dilution, financability, and downside outcomes in weak markets.
Convertible notes are common in pre-seed and seed financings when parties want speed, lower legal cost, and deferred pricing. Unlike SAFEs, notes are debt: they can accrue interest, have a maturity date, and can create real pressure on a company if it cannot raise a priced round in time.
From an allocator perspective, convertible notes are not “simple early money.” They are a pricing and control instrument that affects:
- effective entry valuation,
- dilution outcomes at conversion,
- future round dynamics (especially in weaker markets), and
- cap table cleanliness.
How allocators define convertible note risk drivers
Allocators segment note exposure by:
- Valuation cap and discount: effective entry pricing and conversion advantage
- Interest and maturity: whether debt pressure forces suboptimal financing
- Conversion triggers: what constitutes a qualified financing
- Most favored nation clauses (MFN): how later instruments affect earlier notes
- Cap table stacking: multiple notes over multiple bridges
- Renegotiation dynamics: extensions, resets, and restructuring in down markets
Allocator framing:
“Does this note create clean, predictable conversion into equity—or introduce maturity risk and cap table fragility?”
Where notes sit in venture financing
- early financings when a priced round is premature
- bridge financings when a company needs runway
- insider-led extensions when markets tighten
How convertible notes impact outcomes
- can improve speed and reduce legal friction
- can create maturity cliffs if fundraising is delayed
- can add hidden dilution via interest + caps + discounts
- can complicate next rounds if stacking becomes excessive
How allocators evaluate VC managers on note usage
Conviction increases when managers:
- model conversion outcomes explicitly (up/flat/down scenarios)
- avoid maturity structures that force value-destructive decisions
- keep cap tables clean (limit stacking and complexity)
- report effective entry pricing transparently
- demonstrate discipline in down markets (restructuring without poison terms)
What slows allocator decision-making
- portfolios with layered notes and unclear conversion economics
- maturity risk hidden behind “bridge” language
- inconsistent note structures across portfolio
- lack of transparency on renegotiations/extensions
Common misconceptions
- “Notes are safer because they’re debt” → early-stage debt is usually not protective; it can create pressure.
- “Interest is small so it doesn’t matter” → it can materially change conversion economics in stacked notes.
- “Notes are always founder-friendly” → maturity can be founder-hostile in bad markets.
Key allocator questions
- What are your standard cap/discount/maturity terms by stage?
- How often do notes convert cleanly vs get extended/restructured?
- How do you avoid cap table stacking?
- What is the downside case if no qualified financing occurs?
- How do you report effective valuation and dilution outcomes?
Key Takeaways
- Convertible notes are equity pricing tools plus maturity risk
- Cap stacking and maturity cliffs can impair financability
- Strong managers use notes with disciplined terms and transparent modeling