Convertible note

A convertible note is a loan to a company that is designed to turn into shares instead of being repaid. The investor lends money now. The note earns interest and has a maturity date, like other debt, but when the company raises a priced round, the balance converts into shares, usually on better terms than the new investors get.

How a convertible note converts

The note names a qualifying event, typically an equity round above a minimum size. When it happens, the principal and the interest that has built up convert into shares. Like a SAFE, a note usually has:

• A valuation cap, the highest valuation at which it converts.
• A discount off the price new investors pay.

When the note matures

The difference from a SAFE is that a note is debt. If the maturity date arrives before any conversion, the note's terms decide what happens next. The company may have to repay it, the note may convert at a set valuation, or the holders may agree to extend it. A company that cannot repay a note at maturity has a real problem, which is why many issuers now prefer the SAFE.

Convertible notes in a crowdfunding raise

Convertible notes are permitted in Regulation Crowdfunding and Regulation A+ offerings. For crowd investors they carry the same main caveat as a SAFE: they own no shares until conversion, and conversion depends on events the company controls. The offering documents must describe the interest rate, maturity, conversion terms, and what happens at maturity, and the marketing must match them.

Further reading

• The 17 decisions to make before your crowdfunding raise launches

This page is general information about securities, not legal or investment advice. Whether a convertible note fits a particular offering, and what its terms should be, is a question for the company's securities counsel.