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Convertible promissory notes are debt instruments that convert to equity at a future financing event. They’ve been a staple of early-stage startup financing for decades, offering a way to raise capital while deferring valuation discussions.
A convertible note is debt that automatically converts to equity (usually preferred stock) when you raise a qualified equity financing round. Until conversion, it’s a liability on your balance sheet.

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Understanding convertible notes

Convertible notes bridge the gap between needing capital now and being ready to price an equity round later.

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Why companies use convertible notes

The core benefit of convertible notes:Early-stage companies are difficult to value:
  • No revenue or minimal traction
  • Unclear product-market fit
  • Uncertain market size
  • High failure risk
Convertible notes let you:
  • Raise capital without setting a valuation
  • Wait until you have more data (traction, revenue, users)
  • Let the market set your valuation at Series A
  • Avoid difficult valuation negotiations
If you’re pre-revenue and pre-product, defending a specific valuation is nearly impossible. Convertible notes make sense.
Convertible notes are faster than equity rounds:Equity rounds require:
  • Valuation negotiation
  • Preferred stock terms negotiation
  • Board composition agreements
  • Investor rights agreements
  • Extensive due diligence
  • Timeline: 6-12 weeks
Convertible notes require:
  • Discount and cap negotiation
  • Simple note agreement
  • Basic diligence
  • Timeline: 2-4 weeks
Common use case: Bridge to Series AScenario:
  • You’re 6 months from Series A
  • You need $500K to get there
  • Don’t want to do a full equity round
Solution:
  • Issue convertible notes to bridge
  • Notes convert in Series A
  • Avoids setting intermediate valuation
  • Keeps cap table clean

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Convertible note structure

Convertible notes have several key components that determine their economic terms.

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Principal terms

The investment amount
  • Amount investor pays for the note
  • Face value of the debt
  • Earns interest until conversion or repayment
Example:
  • Investor purchases note for $100,000
  • Principal amount: $100,000
  • This amount will convert to equity (plus accrued interest)
Multiple notes can be issued with different principal amounts to different investors.

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Conversion economics

The discount and cap determine how many shares noteholders receive when converting.
Gives noteholders a discount to the qualified financing priceStandard discount rates:
  • 15% - Most common
  • 20% - Also common
  • 10% - Lower end, very founder-friendly
  • 25% - Higher end, more investor-friendly
How it works:
Series A price: $1.00 per share
Note discount: 20%
Note conversion price: $1.00 × (1 - 0.20) = $0.80

$100,000 note converts to:
$100,000 ÷ $0.80 = 125,000 shares

vs. Series A investor getting:
$100,000 ÷ $1.00 = 100,000 shares

Noteholder gets 25% more shares for same money
Economic rationale:
  • Compensates early investor for higher risk
  • Rewards capital deployed before valuation was known
  • Standard market practice
If you have both a discount and a cap, notes convert at whichever price gives the noteholder more shares (the lower price).
Sets a maximum effective valuation for note conversionWhy caps exist: If your valuation increases dramatically between the note and qualified financing, noteholders could get diluted heavily. The cap protects them.How valuation caps work:
Note terms:
- Principal + interest: $105,000
- Valuation cap: $6M
- Discount: 20%

Qualified Financing:
- Pre-money valuation: $12M
- Price per share: $2.00
- Outstanding shares: 6M

Option 1 - Using discount:
$2.00 × 80% = $1.60 per share
$105,000 ÷ $1.60 = 65,625 shares

Option 2 - Using cap:
Cap price = $6M cap ÷ 6M shares = $1.00 per share
$105,000 ÷ $1.00 = 105,000 shares ✓ Better for investor

Note converts at $1.00 (cap price)
Noteholder gets 105,000 shares
Setting the cap:
  • Should be 50-70% of expected qualified financing valuation
  • Too low: Excessive founder dilution
  • Too high: Doesn’t protect noteholder
  • Typical seed stage: 4M−4M - 10M
The cap is often more important than the discount. In a successful company, the cap determines conversion price more often than the discount does.
How notes convert to equity
1

Calculate conversion price

Determine the lower of:
  1. Qualified financing price × (1 - discount %)
  2. Valuation cap ÷ fully-diluted shares
Noteholders get the lower price (more shares).
2

Determine conversion amount

Total amount converting:
  • Principal amount
  • Plus all accrued unpaid interest
  • As of the conversion date
Interest stops accruing 0-10 days before conversion (per note terms).
3

Calculate shares issued

Shares = Conversion Amount ÷ Conversion PriceExample:
  • Conversion amount: $107,500
  • Conversion price: $0.80
  • Shares issued: 134,375
Round down if fractional shares; pay cash for fraction.
4

Determine stock class

Standard approach: Notes convert to same class as qualified financing investors (e.g., Series Seed Preferred).Shadow series approach: If note conversion price < qualified financing price:
  • Company may create shadow series (e.g., “Series Seed-1”)
  • Identical rights to Series Seed
  • Different liquidation preference per share
  • Liquidation preference = 1× conversion price (not 1× QF price)
Check your note agreement to see which approach applies.
What happens if you’re acquired before a qualified financingOption 1: Automatic repayment (most common)
Company repays:
- Outstanding principal
- Plus accrued unpaid interest
- Plus optional premium (0-50% of principal)
Example:
  • Note balance: $107,500 (principal + interest)
  • Premium: 20% of 100,000=100,000 = 20,000
  • Total payout: $127,500
Option 2: Holder election Noteholder chooses:
  • (a) Repayment (principal + interest + premium), OR
  • (b) Convert to common at valuation cap and participate in acquisition
Option 3: Automatic conversion
  • Note converts to common stock at cap
  • Noteholder participates in acquisition as stockholder
  • Gets pro rata share of acquisition proceeds
Make sure your note terms clearly specify change of control treatment. Ambiguity here can derail an acquisition.

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Series Seed convertible note documents

The Series Seed package includes standardized convertible note documents from Cooley LLP.

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Document components

Non-binding summary of proposed note termsKey sections:
  • Financing amount and investors
  • Interest rate and maturity date
  • Qualified financing definition
  • Conversion provisions (discount and/or cap)
  • Change of control treatment
  • Optional provisions (MFN, conversion at maturity, etc.)
  • Documentation reference
  • Expense allocation
See our term sheets guide for detailed guidance.
Series Seed term sheets reference CooleyGO’s automated document generator, ensuring consistency between term sheet and final documents.

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Optional provisions

Automatic upgrade to better terms if offered to later noteholdersHow MFN works:
  1. You issue Note A: 5% interest, 20% discount, $6M cap, with MFN
  2. Later, you issue Note B: 5% interest, 25% discount, $5M cap
  3. Note B has “material terms that are more favorable” to holder
  4. Company notifies Note A holder
  5. Note A holder can elect to adopt Note B terms
  6. Note A is amended to match Note B (except principal/interest already accrued)
Founder implications:
  • Limits flexibility to offer different terms to different investors
  • Can create cap table complexity
  • May prevent you from improving terms for strategic investors
  • Standard notification: 30 days to provide notice after new note
  • Holder election: 5 days to elect after receiving notice
When to accept MFN:
  • Very early notes where terms are uncertain
  • Short duration (e.g., “MFN applies only to notes issued in next 90 days”)
  • Strategic investor where relationship matters more than terms
MFN provisions can significantly complicate future fundraising. Try to avoid them or limit their duration.
Optional conversion if you raise equity below qualified financing thresholdExample:
  • Note defines qualified financing as $1M+
  • You raise $500K equity round
  • Not a qualified financing (doesn’t auto-convert)
  • But noteholders may want to convert anyway
Two approaches:1. Majority holder option:
  • Holders of majority of notes can elect to treat it as qualified financing
  • All notes convert on same terms
  • Coordinates group decision
2. Individual holder option:
  • Each noteholder decides independently
  • Creates complexity (some convert, some don’t)
  • Less common
Include this provision if there’s any chance you might raise a smaller equity round before a full Series A.
Prevents company from repaying notes early without consentStandard Series Seed provision: “The Company may not prepay this Note prior to the Maturity Date without the consent of the Majority Holders.”Why it matters:
  • Noteholders want notes to convert (and get equity upside)
  • Don’t want company to repay with cash before conversion
  • Protects noteholders’ conversion option value
Founder perspective:
  • Standard and reasonable
  • If you wanted to repay, you could negotiate
  • But early repayment rarely makes sense
Almost always included. Don’t fight this provision.
Optional reporting obligations to noteholdersNot standard in Series Seed notes, but sometimes negotiated:
  • Annual financial statements
  • Quarterly updates
  • Notice of material events
Considerations:
  • Adds administrative burden
  • Noteholders will get info rights after conversion anyway
  • Large noteholders ($250K+) more justified in asking
Generally, try to avoid information rights for notes. They’ll get them soon enough when notes convert.

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Negotiating convertible note terms

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Key negotiation points

1

Interest rate

Target: 4-6% for most seed-stage notesLower is better for founders:
  • Less dilution at conversion
  • Lower cost of capital
Arguments for lower rate:
  • You have strong valuation cap (cap matters more)
  • Short time to expected qualified financing
  • Investor is strategic, not just financial
When to accept higher rate:
  • Weak negotiating position
  • Longer maturity date (18+ months)
  • No valuation cap or high cap
Don’t spend too much energy negotiating interest rate. The difference between 4% and 6% over 18 months is minimal (~3% more dilution). Focus on cap and discount.
2

Valuation cap

Most important economic termSetting the right cap:
  • Should be 50-70% of expected qualified financing valuation
  • If you expect 12MSeriesAvaluation,capshouldbe12M Series A valuation, cap should be 6M-$8M
Too low:
  • Excessive founder dilution
  • May give noteholders more % than you intended
  • Hard to justify to later investors
Too high:
  • Doesn’t protect noteholders adequately
  • May result in notes not converting (if QF valuation is lower)
Negotiating approach:
  1. Model your expected Series A valuation
  2. Propose cap at 60% of that
  3. Be prepared to justify with traction, market size, comparables
  4. Consider discount as trade-off (lower cap with smaller discount)
3

Discount rate

Target: 15-20%Standard market terms:
  • 15% - Lower end, founder-friendly
  • 20% - Most common, balanced
  • 25% - Higher end, investor-friendly
Trade-offs:
  • Can negotiate lower discount for lower cap
  • Can negotiate higher discount to avoid valuation cap
  • Discount matters more if valuation grows slowly
Example trade:
  • Investor wants: $5M cap, 20% discount
  • You propose: $6M cap, 15% discount
  • Better for you, reasonable for investor
4

Maturity date

Target: 18-24 months12 months:
  • Too short
  • Doesn’t give enough runway to raise qualified financing
  • Avoid unless absolutely necessary
18 months:
  • Common and reasonable
  • Gives time for one fundraising cycle
  • Standard market term
24 months:
  • Safer for founders
  • Allows for delays, pivots, market changes
  • Preferred if you can get it
36 months:
  • Very long
  • Investors may resist
  • Only if you’re very early or uncertain timeline
Don’t agree to 12-month maturity unless you have extremely high confidence in raising your qualified financing within 6-9 months. Give yourself buffer.
5

Qualified financing threshold

Target: Size of your expected Series Seed or Series ASetting the threshold:If you expect to raise:
  • 1M−1M-2M seed round → Set threshold at 750K−750K-1M
  • 3M−3M-5M Series A → Set threshold at 1.5M−1.5M-2M
  • 5M+SeriesA→Setthresholdat5M+ Series A → Set threshold at 2M-$3M
Too low:
  • Could trigger on smaller friends/family round
  • Forces conversion before you’re ready
  • May result in messy cap table
Too high:
  • May never trigger
  • Notes reach maturity instead
  • Creates crisis scenario
Standard exclusions:
  • Exclude convertible securities (notes/SAFEs) converting in round
  • Exclude strategic partner investments
  • Exclude option exercises
  • Requires “principal purpose of raising capital”

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Common convertible note mistakes

The problem:
  • Issue notes at different times
  • Different caps: 5M,5M, 6M, $8M
  • Different discounts: 15%, 20%, 25%
  • Some with MFN, some without
  • Creates mess at conversion
Why it’s bad:
  • Hard to explain to Series A investors
  • MFN provisions may trigger
  • Different notes convert at different prices
  • Complex cap table
The fix:
  • Set terms at beginning of note round
  • Use same terms for all investors in that round
  • Only change terms when starting a new distinct round
  • Document rounds clearly (“Q1 2024 Note Round”)
The problem:
  • Issue 1.5Minnoteswith1.5M in notes with 6M cap
  • Don’t model conversion
  • Surprised by dilution at Series A
Example:
Notes: $1.5M at $6M cap
Series A: $3M at $12M pre-money

Founder assumption: 20% dilution from Series A
Reality:
- Notes convert first at $6M cap = 25% dilution
- Then Series A dilutes the post-note cap table = 20%
- Total: ~40% dilution
The fix:
  • Model cap table after note conversion
  • Assume notes convert at their cap (worst case for founders)
  • Calculate total dilution including both notes and equity
  • Use cap table software: Carta, Pulley
The problem:
  • Notes mature before you raise qualified financing
  • Now you face repayment obligation or forced conversion
  • Creates crisis and distraction
What happens at maturity:
  • If notes require repayment: Company faces insolvency risk
  • If notes auto-convert: May convert at unfavorable terms
  • If holders elect: Uncertainty and negotiation required
The fix:
  • If maturity is approaching and you haven’t raised QF:
    1. Start negotiations with noteholders early (6 months before)
    2. Options: (a) extend maturity, (b) convert now on agreed terms, (c) repay if possible
    3. Get majority holders aligned first
    4. Document any amendments properly
Don’t let notes mature without a plan. Start discussing with noteholders 6+ months in advance.
The problem:
  • Missing signed notes
  • No wire confirmations
  • No board approvals
  • Missing Form D filings
  • Sloppy records
Why it matters:
  • Series A investors will scrutinize in due diligence
  • Missing documents can kill your financing
  • Securities law violations can result
  • Board approval problems can invalidate notes
The fix: For each note, maintain:
  • ✓ Executed note agreement
  • ✓ Wire transfer confirmation
  • ✓ Board consent approving note issuance
  • ✓ Investor questionnaire
  • ✓ Form D filing (if required)
  • ✓ Updated cap table
Use services like Clerky or Carta to manage documentation.

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Convertible notes vs. SAFEs

Choosing between notes and SAFEs depends on stage, investors, and situation.
FeatureConvertible NoteSAFE
InstrumentDebtFuture equity right
Interest2-8% annuallyNone
Maturity18-24 monthsNone
Repayment obligationYesNo
ComplexityModerateSimple
Document length15-20 pages5 pages
Legal fees5K−5K-15K2K−2K-5K
Balance sheetLiability (debt)Off balance sheet
Best forBridge roundsPre-seed/seed
Investor familiarityUniversalCommon in tech hubs
Time to close2-4 weeksDays

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Best practices

1

Use Series Seed documents

Don’t create custom note documents. Use standardized forms:These are well-drafted, market-standard, and familiar to investors and lawyers.
2

Model your cap table

Before issuing notes:
  • Build cap table model showing note conversion
  • Assume notes convert at cap (worst case)
  • Calculate total dilution through Series A
  • Ensure founders retain adequate ownership
Tools: Carta, Pulley, Capshare
3

Get board approval first

Before executing your first note:
  • Hold board meeting or obtain written consent
  • Approve note form and maximum amount
  • Authorize officers to execute notes
  • Reserve shares for conversion
  • Document in minutes/consent
See our board consent guide.
4

Maintain excellent records

For each note:
  • Executed note agreement
  • Investor questionnaire
  • Wire confirmation
  • Updated cap table
  • Form D if required
Keep everything organized in a data room for Series A diligence.
5

Communicate with noteholders

Even though notes don’t require it:
  • Send quarterly updates
  • Notify of major milestones
  • Give advance notice of qualified financing
  • Keep investors engaged
These people gave you capital when you needed it. Keep them informed.
6

Plan conversion carefully

Before raising your equity round:
  • Calculate exactly how notes will convert
  • Ensure qualified financing threshold is met
  • Verify all note documentation is in order
  • Brief Series A investors on note conversion
  • Model post-conversion cap table
No surprises at closing.

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Resources and templates

Series Seed documents

Complete convertible note package including term sheet, note form, and consents

CooleyGO generator

Automated document generator for Series Seed convertible notes

Techstars documents

Techstars convertible note and bridge financing documents

Cap table tools

Model note conversion:

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Next steps

Compare to SAFEs

Understand the differences between convertible notes and SAFE agreements

Equity term sheets

Learn about the qualified financing that triggers note conversion

Board consent

Get the board approvals you need before issuing convertible notes

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