Raising capital is never easy, especially in today's more disciplined funding environment. For early-stage startups looking to bring in quick funding without setting a valuation, convertible notes remain a popular tool. These flexible, debt-based instruments allow startups to delay pricing their equity while still accessing critical capital. But they come with trade-offs: complexity, potential repayment risk, and dilution scenarios that can catch founders off guard.
This guide explores the mechanics of convertible notes—how they work, why founders use them, and what investors expect in 2025’s fundraising climate. We compare convertible notes with other funding instruments like SAFEs and priced rounds, break down current market trends, and offer actionable advice on structuring these deals with confidence.
What a Convertible Note Is
A convertible note is a short-term debt instrument that converts into equity during a future financing round—usually your next priced equity round. Rather than determining a valuation immediately, a convertible note delays that conversation, which can speed up negotiations and reduce legal complexity.
Until conversion, a convertible note functions as a loan, often accruing interest and carrying a maturity date. When a "qualified financing" occurs (typically defined as a raise above a certain threshold, e.g., $1 million), the debt converts into preferred equity, usually with a discount or a valuation cap.
How It Works and Key Terms to Understand
When you raise capital using a convertible note, you're issuing a legal promise to convert debt into equity when a triggering event occurs—typically your next equity round. Until that event, investors hold a loan that accrues interest, but they’re not actual shareholders.
The key terms you’ll negotiate are:
Discount Rate
Investors receive a discount on the price per share in your next round, typically between 15–25%. For example, if new investors pay €1 per share, your note holders may convert at €0.80.
Valuation Cap
This sets the maximum valuation at which the note will convert into equity, regardless of your next round's valuation. It ensures early investors benefit from the upside they helped create.
If your cap is €10M and your Series A is priced at €20M, your note converts at the lower cap, giving investors more equity.
Interest Rate
Since a convertible note is debt, it typically accrues simple interest—usually 4–8% annually. This interest is added to the principal and converted into equity.
Maturity Date
The point at which the note becomes due. If a qualified financing hasn’t occurred, investors may request repayment or renegotiate terms. Common maturity windows are 18–36 months.
While it's rare for early-stage investors to demand repayment, it’s legally possible and worth planning for.
When to Use a Convertible Note
Convertible notes are commonly used in early-stage fundraising due to their speed, simplicity, and flexibility. They allow startups to postpone complex valuation discussions while still bringing capital in the door—an especially valuable feature in uncertain or fast-moving markets. Startups often choose this route when they anticipate a significant valuation uplift in the near future, or when they're still iterating on product-market fit and want to remain agile.
Convertible notes are particularly useful when:
- You're raising pre-seed or seed capital
- You want to move fast and minimize legal work
- The market is volatile and setting a valuation feels premature
- You expect to raise a priced round within 12–18 months
They function as a strategic "pause button" that lets startups build value before locking in equity terms.
However, they’re not ideal if:
- You’re unsure when your next priced round will occur
- You’re stacking multiple notes (which can over-dilute your cap table)
- You can’t clearly communicate terms to investors
Convertible Notes vs. SAFE Notes
While both convertible notes and SAFEs delay equity pricing, they differ in structure and complexity:
In sectors like AI where investor demand is red-hot, SAFEs are becoming more common due to their simplicity. According to Business Insider, founders in the 2024 AI boom are using SAFEs to raise millions without board seats, legal overhead, or valuation debates. However, many investors remain cautious—concerned about ownership clarity and enforceability.
Convertible notes may be preferred by:
- Investors who want downside protection
- Startups with less negotiating leverage
- Founders looking to show commitment to future institutional rounds
Pros and Cons vs. SAFE Notes and Priced Rounds
When evaluating funding instruments, it’s important for founders to weigh the trade-offs between speed, legal complexity, investor preference, and long-term equity structure. Convertible notes fall somewhere between SAFEs and priced rounds in terms of structure. They offer more investor protection than SAFEs while avoiding the heavier cost and diligence process of a priced equity round. Each option serves a purpose depending on your company’s stage, investor relationships, and strategic goals.
Pros of Convertible Notes:
- Delay valuation decisions
- Faster and cheaper to execute than priced rounds
- Provide investor protections through interest and caps
- Familiar structure to many investors
Cons of Convertible Notes:
- Still considered debt until converted
- Maturity dates can create pressure
- Can lead to cap table complexity if multiple notes are stacked
Compared to Priced Rounds:
- Convertible notes are faster and less expensive
- Priced rounds are better for signaling, governance, and long-term planning
Founder Tips for Structuring a Convertible Note
Navigating a convertible note raise successfully requires both strategic foresight and clarity in communication. Founders should understand how different terms affect ownership, investor expectations, and downstream fundraising. Poorly structured notes can lead to misunderstandings or legal risk, especially if a startup stacks several without proper alignment. Taking time to plan your note terms—just like you'd plan your product roadmap—can pay dividends later.
- Avoid stacking too many notes: If multiple investors hold notes, conversion can become complex and messy.
- Set realistic maturity timelines: Choose a date well after your planned raise, with a buffer.
- Cap wisely: Too low and you’ll over-dilute. Too high and investors may walk away.
- Be transparent: Send regular updates and involve note holders in future planning.
- Plan for scenarios: What happens if you raise less than expected—or don’t raise at all?
How Market Dynamics in 2024–2025 Are Shaping Usage
The 2024–2025 funding environment is shaped by higher investor expectations, increased diligence, and fewer large-scale Series A rounds. According to the Financial Express, convertible note issuance surged as startups sought to avoid down rounds and preserve valuations.
Carta and PitchBook data show rising bridge rounds and delays in traditional equity funding. Convertible notes give startups a path to raise now while targeting better terms later.
But flexibility comes with responsibility: in this environment, founders need a compelling narrative, data-driven metrics, and a clear follow-up plan.
Convertible notes remain one of the most flexible tools for early-stage startup fundraising in 2025. They allow founders to focus on execution while deferring hard valuation conversations. But with flexibility comes responsibility.
Understand your terms. Educate your investors. Use caps and discounts wisely. And always map out how the note fits into your longer fundraising timeline.
