Company setup and early instruments
Convertible note terms
Principal, interest, maturity, discount, cap and the qualified-financing trigger that turns a loan into stock.
A convertible note is a loan designed to turn into equity later, usually when you close a priced preferred round. The investor wires cash today. You owe principal plus interest. If a qualified financing happens, the note converts into preferred at a discount and/or valuation cap instead of being repaid in cash.
Concept
Convertible debt sits on the balance sheet as a liability until it converts. A standard YC SAFE has no interest and no maturity. In a dissolution or sale before conversion, debt is typically paid before equity — including before SAFE holders.
The big idea
An IOU that expects to be paid in shares at the next priced round is the picture. It still has a due date. That is the difference from a SAFE, and the risk.
| Term | What it means | Typical range (seed / bridge) |
|---|---|---|
| Principal | Cash invested | Check size |
| Interest | Accrues on principal (often simple) | ~2–8% per year |
| Maturity | Date the note is due if not converted | 12–24 months common |
| Discount | Conversion price = round price × (1 − discount) | 15–25% |
| Valuation cap | Ceiling valuation used to price conversion | Negotiated |
| Qualified financing | Minimum raise that triggers automatic conversion | Often $1M–$5M+ of preferred |
Many notes use both a discount and a cap: the investor gets the better (lower) conversion price. Some are discount-only or cap-only. Read the PDF you signed. "Market" is a range, not a law.
Automatic conversion usually fires on a preferred round above a dollar threshold. Optional or mandatory conversion can also apply on a change of control or at maturity. Some notes repay principal + interest (or a multiple) on a sale; others convert into preferred-like economics. If the threshold is $5M and you raise a $2M "mini" preferred round, the note may not auto-convert. Align the threshold with how you actually raise.
Walking through interest
Interest usually accrues into the conversion amount. You are not writing monthly checks. You are giving the investor more dollars that convert into shares.
Conversion amount = Principal × (1 + interest_rate × years_elapsed)
# simple interest; compounding notes differThat larger amount buys more shares at the same conversion price — extra dilution for founders and employees. A $500k note at 6% simple for 1.5 years adds $45k, which is 45,000 extra shares if the conversion price is $1.00. Small here; material if the note is large, old, or high-rate.
Common mistakes
- Treating the note like a SAFE. It has a due date and a place in line ahead of equity.
- Ignoring the qualified-financing floor. A small preferred round may leave the debt on the books.
- Skipping the interest line when you quote ownership into the next round.
Check yourself
A $500k note at 6% simple sits for 18 months. What converts, besides the $500k?
$45,000 of accrued interest — $500k × 0.06 × 1.5.
Why does a $2M preferred close not always convert a note with a $5M qualified-financing threshold?
Automatic conversion needs the threshold. Below it, the debt can stay due.
Key takeaways
- A note is debt: principal, interest, maturity, then conversion on a qualified financing.
- Interest usually adds to the conversion amount and buys extra shares.
- Discount, cap and the trigger are the terms that decide the share count. Model from your PDF.
Further learning
Next, note conversion math — better of discount or cap, with numbers.
Related
Convertible notes
Debt that converts — when notes still beat SAFEs, and the map of terms, math and maturity.
Note conversion math
Better of discount or cap, plus accrued interest, walked through a $500k note into a $2.00 Series A.
SAFEs
The post-money SAFE as a right to future equity — valuation caps, discounts, MFN, pro-rata side letters and the ownership math founders must run before signing.