A convertible note is a loan that is intended to convert into equity rather than be repaid in cash. The investor lends the company money, and when the company raises a priced equity round, the loan principal (and accrued interest) converts into shares at a discount to the price paid by new investors. The two key economic terms are the discount rate (typically 10–25%, meaning early investors get shares cheaper than new investors) and the valuation cap (a ceiling on the price at which the note converts, protecting early investors if the company's valuation surges before conversion).
Convertible notes were the dominant instrument for early-stage US fundraising from roughly 2005 to 2013, before the SAFE was introduced as a simpler, non-debt alternative. Notes carry a maturity date (typically 18–24 months) at which the note must either convert, be repaid, or be extended — this creates a legal obligation that SAFEs do not. Despite this, convertible notes remain common where investors prefer the legal familiarity of debt instruments.
The key risk for founders is maturity: if a priced round hasn't been raised by the maturity date, investors can technically call the debt, though in practice most negotiate an extension. For investors, the risk is the "1x liquidation preference" of the converted shares, which in some structures can create economic misalignment at exit.