Convertible Note
A short-term debt instrument that automatically converts to equity in a future financing round, typically with favorable terms for early investors.
Definition
A convertible note is a form of debt financing that converts to equity when certain conditions are met, usually when the company raises its next financing round. It allows companies to raise funds quickly without determining a valuation immediately, while giving investors the right to convert their debt to equity at favorable terms.
Key Terms
- • Principal: The amount invested
- • Interest Rate: Annual interest (typically 5-8%)
- • Maturity Date: When debt becomes due if not converted
- • Conversion Discount: Percentage discount on next round price
- • Valuation Cap: Maximum valuation for conversion
- • Conversion Trigger: Event that causes conversion
Real-World Example
Bridge Financing: $500K convertible note with 20% discount and $5M cap
When the company raises Series A at $8M pre-money, the note converts at the lower of the $5M cap or 20% discount, giving the note holder better terms.