A convertible note is a type of debt that converts to equity at a later date. Investors often use convertible notes when investing in early-stage companies because it gives them the potential to convert their investment into equity at a discounted price. This is advantageous for the investor because it allows them to minimize their risk while still having the opportunity to participate in the upside of the company if it is successful.
There are two main types of convertible notes:
Convertible notes are often used in conjunction with SAFEs (Simple Agreements for Future Equity). SAFEs are similar to convertible notes in that they are also debt instruments that convert to equity at a later date. However, SAFEs do not accrue interest and do not have a maturity date. For these reasons, SAFEs are often more attractive to founders than convertible notes.
Convertible notes and SAFEs are popular financing instruments among startups and investors alike. They offer a way for investors to minimize their risk while still having the opportunity to participate in the upside of the company if it is successful. If you're a startup founder considering raising money from investors, be sure to educate yourself on these financing instruments so that you can make the best decision for your company.