Convertible Note Template: A Founder's Guide

A convertible note lets a startup raise money before it is ready to set a price on itself. Instead of selling shares at a fixed valuation, the company borrows money that later converts into equity, usually at the next financing round. It is one of the most common instruments for seed and pre-seed rounds, and it is also one of the easiest to get wrong.

This guide walks through what a convertible note is, how each term works, how to write one, and the mistakes that quietly cost founders equity.

What is a Convertible Note?

A convertible note is a short-term loan that converts into equity rather than being repaid in cash. An investor lends the company money, and instead of getting that money back with interest, they receive shares when a triggering event happens, normally a priced equity round.

Because the note is structured as debt, it has features a loan would have: a principal amount, an interest rate, and a maturity date. But everyone signing it expects the debt to turn into stock, not to be paid back.

The appeal is timing. Early on, a startup has little revenue and almost no objective basis for a valuation. A convertible note lets the company take money now and defer the valuation argument until a later round, when there is more information to price the company fairly.

Convertible Note vs. SAFE vs. Priced Round

These three instruments solve the same problem in different ways.

• Priced equity round. The company sets a valuation, sells shares at a per-share price, and the investor owns equity immediately. Clean, but slow and expensive to negotiate.
• Convertible note. Debt that converts to equity later. Carries interest and a maturity date. Gives investors a creditor's position until conversion.
• SAFE. A simple agreement for future equity. Not debt, so no interest and no maturity. Faster and founder-friendly, but offers the investor less protection.

If you are weighing a note against a SAFE, the SAFE agreement guide covers that instrument in detail. The short version: choose a note when investors want the security of debt, and a SAFE when both sides want speed and simplicity.

The Core Terms of a Convertible Note

Four terms do most of the work in a convertible note. Get these right and the rest of the document is mostly boilerplate.

Valuation Cap

The valuation cap is the highest company valuation at which the note will convert. It protects the early investor from being penalized for the company's later success.

Say an investor puts in $100,000 on a note with a $5 million cap. If the company later raises a priced round at a $10 million valuation, the note still converts as if the company were worth $5 million. The investor effectively buys shares at half price, because they took the risk early.

A lower cap is better for the investor and more dilutive for the founder. A higher cap, or no cap at all, favors the founder. The cap is almost always the term that gets negotiated hardest.

One detail that trips up first-time founders is whether the cap is measured pre-money or post-money. A pre-money cap is set before the new round's money is added; a post-money cap includes it. Post-money caps give investors a fixed percentage of the company that does not shrink as you raise more, which sounds minor but can cost founders several extra points of ownership once a few notes stack up. Always confirm which basis the note uses before signing.

Discount Rate

The discount rewards the early investor with a lower price than the new money coming in at the next round. A 20 percent discount means the note converts at 80 percent of the price paid by the new investors.

Discounts usually fall between 10 and 25 percent. When a note has both a cap and a discount, it converts using whichever gives the investor the better deal, not both stacked together.

Interest Rate

Because the note is a loan, it accrues interest, typically 2 to 8 percent a year. The interest is rarely paid in cash. Instead it adds to the principal, and the larger amount converts into equity. A note with a higher rate simply hands the investor a few more shares at conversion.

Maturity Date

The maturity date is when the loan technically comes due, often 18 to 24 months out. If the note has not converted by then, the parties have to decide what happens: extend the date, convert at a fallback valuation, or repay the principal and interest. Since most early companies cannot repay in cash, the practical outcome is usually an extension or a negotiated conversion.

How Conversion Actually Works

Conversion is triggered by an event, and a well-written note spells out each scenario.

Qualified financing. The standard trigger. When the company raises a priced round above a stated threshold (say $1 million), the note automatically converts into the same class of shares the new investors buy, adjusted by the cap and discount.

Maturity. If the note reaches its maturity date without a qualifying round, it needs a fallback. Good notes include a conversion mechanism at a pre-agreed valuation so the investor is not left holding a defaulted loan.

Change of control. If the company is acquired before the note converts, the note should say what the investor gets. Common options are repayment at a multiple of principal (for example, 1x or 2x) or conversion into equity just before the sale, whichever the investor prefers.

Leaving any of these undefined is where disputes start. A note that only describes the qualified-financing case leaves the maturity and acquisition outcomes to a tense negotiation later.

A Worked Conversion Example

Numbers make the cap and discount easier to follow. Say an investor puts in $100,000 on a note with a $5 million cap, a 20 percent discount, and 6 percent interest. A year later the company raises a priced round at a $10 million valuation, with new shares priced at $1.00 each.

First, add the accrued interest. After one year at 6 percent, the $100,000 has grown to roughly $106,000, and that full amount converts.

Now compare the two methods. The discount converts the note at 80 percent of the new price, or $0.80 a share, which buys about 132,500 shares. The cap converts as if the company were worth $5 million instead of $10 million, which halves the price to $0.50 a share and buys about 212,000 shares. The note uses whichever is better for the investor, so the cap wins and they receive about 212,000 shares while new investors pay a full dollar for theirs.

That gap is the reward for investing early, and it is also the dilution the founders agreed to when they signed. Running this math before signing, rather than after the priced round, is the single best habit a founder can build around notes.

How to Write a Convertible Note: Step by Step

Step 1: Identify the parties. Use the company's full legal name and state of incorporation, and the investor's full legal name. The company is the borrower; the investor is the lender.

Step 2: State the principal amount. This is the money being invested. If multiple investors are coming in on the same terms, you can issue separate notes from one template rather than one shared document.

Step 3: Set the interest rate. Pick a rate in the 2 to 8 percent range and state that interest accrues and converts rather than being paid in cash.

Step 4: Set the maturity date. Choose a date 18 to 24 months out, and describe what happens if conversion has not occurred by then.

Step 5: Define the valuation cap and discount. State both numbers clearly, and specify that conversion uses whichever produces the better price for the investor.

Step 6: Describe the conversion triggers. Cover qualified financing, maturity, and change of control. For each, say exactly what shares or payment the investor receives.

Step 7: Add standard provisions. Include governing law, what counts as a default, whether the note can be prepaid, and how amendments are made. Both parties sign, and the signatory for the company must have authority to bind it.

Common Mistakes Founders Make

Stacking the cap and the discount. A note should convert using the cap or the discount, whichever helps the investor more. If the document reads as though both apply at once, investors can claim a far larger stake than intended.

Ignoring the maturity date. Founders sign 24-month notes and forget them. When maturity arrives without a priced round, the investor is suddenly a creditor who can, in theory, demand repayment. Track every note's maturity and renegotiate well before the deadline.

Raising too much on notes. Each note dilutes the founders at conversion, and the dilution is invisible until the priced round runs the math. Stack enough uncapped or low-cap notes and founders can be shocked by how little they own afterward. Model the conversion before signing, not after.

Inconsistent terms across investors. Issuing notes with different caps, discounts, and maturity dates to different investors creates a tangle that complicates the next round. Keep the terms uniform within a single raise.

No change-of-control language. If an acquisition offer arrives while notes are outstanding, an undefined note becomes a bargaining chip that can hold up the whole deal. Decide the outcome up front.

When a Convertible Note Makes Sense

A convertible note is a strong fit when:

• You are raising a seed or pre-seed round and want to defer the valuation conversation.
• Your investors prefer the protection of a debt instrument over a SAFE.
• You are taking money from angels, friends, or family and want a clean, written structure without a full priced round.
• You expect a priced round within 18 to 24 months that the note can convert into.

It is a weaker fit when a priced round is far off, when you are stacking so many notes that the eventual dilution becomes hard to predict, or when investors specifically want immediate ownership and board rights.

Before you finalize terms, it helps to understand the documents that surround a note. The term sheet guide explains how the headline terms of a round get framed, the founders agreement guide covers how the founding team divides equity that notes will later dilute, and the shareholder agreement guide explains the rights that attach once your investors actually hold shares.

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Generate Your Convertible Note with Contractable

A convertible note looks simple, but the cap, discount, interest, and conversion triggers all interact, and a small drafting slip can cost a founder real equity. Contractable generates a customized convertible note in seconds, with the terms set for your specific round and the conversion scenarios spelled out. You do not need a lawyer or legal background to use it.