How Do Convertible Notes Work?

A convertible note is a short-term debt that can later convert into equity. Your note may convert to equity on the maturity date listed on your subscription agreement, or the conversion may be triggered by a future financing round. Your principal investment will accrue annual interest, and upon the conversion event, you will receive equity at a discount. Both the principal and interest may convert into equity.

Convertible notes do not grant immediate equity to investors. There will not be any shares to reflect your investment until your convertible note converts to equity. 

Key terms associated with a convertible note:

Principal - The principal amount represents the actual amount invested by the noteholder in the convertible note.

Interest rate - Convertible notes have an annual interest rate. This is simple interest, and generally is not paid in cash, but accrues and will be added to the principal balance when a note converts into equity.

Maturity Date - The maturity date is determined by the issuer. It can often be as short as one year, or many years after issuance. StartEngine’s convertible notes typically have a maturity of 2 years. The convertible note may convert into equity by the maturity date, or in the future when a conversion is triggered. The duration from issuance to maturity date is stated in the offering terms. 

Conversion Trigger - is the minimum amount a subsequent equity funding round must raise to trigger the conversion of the convertible note into equity. If a particular offering has a conversion trigger, it will be stated in the offering terms. 

Valuation Cap - represents the highest valuation at which convertible note holders will have their equity share determined.

Discount rate - gives investors a reduced price compared to that paid by the next equity investors. The discount rate is stated in the offering terms.