Convertible Note: An Investor's Guide With Worked Math

A convertible note is a loan to a startup that converts into preferred stock at the company's next priced round instead of being repaid in cash. The investor usually gets a valuation cap, a discount to the round price, or both, plus interest that accrues and converts too. Your return depends largely on the conversion price those terms produce.

For the investor, the note is a bet that a priced round will happen, and that the cap or discount will make the early check worth meaningfully more than one written later. It's also a shrinking corner of the market: Carta's Q1 2026 pre-seed report found convertible notes made up a record-low 7 percent of pre-seed rounds, with SAFEs the default.

Definition: A convertible note is a debt instrument with a principal amount, interest rate, and maturity date that automatically converts into equity at a qualified financing, typically at the lower of a discounted round price and a price implied by a valuation cap.

On paper it's a loan. In practice, very few investors want their money back. What they want is a good price on shares later.

Convertible note conversion math: a worked example

In this illustrative example, an angel invests $100,000 on a note with 5 percent simple interest, a 20 percent discount, and a $6M pre-money valuation cap. Eighteen months later the company raises a Series Seed at $10M pre-money, with 10 million shares outstanding before the round, so new investors pay $1.00 per share.

1. Accrued interest: $100,000 x 5% x 1.5 years = $7,500, so $107,500 converts.
2. Discount price: $1.00 x (1 minus 20%) = $0.80.
3. Cap price: $6M cap / 10 million shares = $0.60.
4. Conversion price: the lower of the two, $0.60.
5. Shares: $107,500 / $0.60 = 179,166 shares (fractions are normally rounded down). The same $100,000 written into the priced round buys 100,000 shares.

The cap only does work when the round prices above it. Holding everything else constant, here's the same note under three next-round outcomes:

These are paper values before later dilution. Real note language defines the share count used for the cap price, so read it closely.

What a convertible note is and how it differs from a SAFE

Notes and SAFEs both defer valuation to a later round. The difference is that a note is debt. Y Combinator's post-money SAFE user guide says a SAFE has no maturity date and is designed to avoid the time spent extending maturities and revising interest rates. A note has both interest and maturity:

• Interest adds to the amount that converts, so the investor ends up with more shares.
• Maturity gives the investor leverage. If no qualified financing closes by then, the note's terms decide what happens: repayment, an agreed extension, or conversion at a pre-set price.
• Priority in a wind-down. A noteholder is a creditor, ahead of equity holders. The same YC guide says a SAFE ranks junior to outstanding indebtedness, including convertible notes. A failed startup, though, rarely has much left to distribute.

Carta's review of pre-seed in 2025 finds that the post-money SAFE with a cap and no discount is still the standard pre-seed instrument, and that notes tend to carry lower caps than SAFEs. Notes still appear, for example in bridge financings, but they seem to be the exception. The investor comparison of SAFE vs. convertible note covers when to choose one over the other, and the SAFE investor guide covers the SAFE side in depth.

The convertible note terms that set your return

1. Valuation cap. The maximum valuation at which the note converts. Cooley GO's primer on convertible debt explains that caps protect investors when the next round's valuation climbs, which would otherwise shrink the early stake. It's often the headline term in the negotiation.

2. Discount. A percentage reduction to the next round's price, typically 15 to 25 percent according to Cooley GO. Vela Wood, a startup law firm, calls 20 percent standard. With both a cap and a discount, the investor converts at whichever gives the lower price.

3. Interest rate. Cooley GO says 6 to 10 percent used to be typical and rates around 4 percent have become more common for early-stage deals, partly because accrued interest works like an extra discount at conversion. Vela Wood reports typically seeing 6 to 8 percent. Interest is usually simple and converts rather than being paid in cash.

4. Maturity date. J.P. Morgan's July 2026 guide puts typical maturities at 12 to 24 months, sometimes longer. Cooley GO notes that notes differ on what happens then: mandatory repayment, repayment at the holder's option, or repayment or conversion at a pre-agreed price.

5. Qualified financing threshold. The note converts automatically only in an equity round of at least a set size, typically one to two times the principal per Cooley GO.

Also read the change of control clause, which sets your payout if the company is sold before conversion, and any most favored nation clause, which lets you adopt better terms given to later investors.

How to evaluate a convertible note deal as an investor

1. Treat the cap as the valuation. In the good scenario, the cap is effectively the price you paid. Diligence the company as if you were buying preferred stock at that price.
2. Model three next-round outcomes. Run the conversion below the cap (the discount controls), at the cap, and at two to three times the cap, as in the table above.
3. Add up the other notes and SAFEs. Stacked instruments convert together and can take a surprising share of the round. Ask for a pro forma cap table with every instrument converted. A long stack with no lead is a pattern we'd slow down on, as we argue in our take on reading the cap table first.
4. Check the qualified financing size against the plan. A $2M threshold on a company planning a $1.5M seed round means the note may not convert when you expect.
5. Decide what you want at maturity. Cooley GO observes that when maturity arrives, companies and investors often agree to extend or simply leave the notes outstanding. If you wouldn't realistically demand repayment from a struggling company, negotiate conversion at a set price at maturity instead.
6. Ask about side letters. Pro rata and information rights are usually not in a short-form note.

Typical convertible note terms in 2026

Terms vary by stage, geography, and negotiating power, and they change over time. These ranges come from the sources above:

• Discount: 15 to 25 percent (Cooley GO), with 20 percent the common default (Vela Wood).
• Interest: roughly 4 to 8 percent simple (Cooley GO, Vela Wood).
• Maturity: 12 to 24 months, sometimes longer (J.P. Morgan).
• Change of control: often 1.5x to 2x repayment or conversion (Vela Wood).
• Caps: Carta's 2025 pre-seed review put median post-money SAFE caps around $10M for rounds between $250K and $1M and $15M for rounds between $1M and $2.5M, with note caps typically lower and more volatile. Carta's Q2 2026 pre-seed report shows the average SAFE or note size up 27 percent year over year to $276,000.

Our read: a $25M cap on a pre-revenue company's $500K note is a seed price for pre-seed risk. We'd push back on that.

"But nobody uses notes anymore"

Close to true at pre-seed. With notes at 7 percent of rounds in Carta's Q1 2026 data, an angel could write checks for years and rarely see one.

But the notes that do show up tend to arrive at the moments that matter most: bridges, insider extensions, a company that has missed plan and needs time. Those are exactly the deals where maturity, interest and priority stop being fine print. Fewer notes doesn't mean less reason to understand them. It means the ones you see are more likely to be carrying risk.

Mistakes investors often make with notes

• Confusing the cap with a guarantee. If the next round prices below the cap, the discount applies and the cap does nothing.
• Ignoring how the cap is applied. A "$6M cap" means different ownership depending on whether it's measured pre-money or post-money and which other notes and SAFEs count in the share base. Ask.
• Skipping the accrued interest. In the example above it added 7.5 percent to the converting amount.
• Forgetting that notes are securities. The company needs an exemption, usually Regulation D. Investor.gov explains that Rule 506(b) allows unlimited accredited investors plus up to 35 other purchasers but no general solicitation, while 506(c) allows advertising if every investor is a verified accredited investor; see 506(b) vs. 506(c).

For founders: the founder-side article on how SAFEs impact dilution runs the same conversion math from the company's chair.

New angels usually meet their first convertible note before they've seen a priced round. 1752vc's Emerging Angels program gives accredited investors who are new to angel investing eight live weeks inside a working fund's investment process, with live diligence calls and deal reviews where instruments like this one come up on real companies.

The bottom line

A note's value lives in three numbers: the cap, the discount and the date. Model all three before you wire, and assume the maturity date is a conversation, not a payday.

The interest rate is what the note promises.

The cap is what it's actually worth.

Key takeaways

• A convertible note is a loan that converts into preferred stock at the next priced round, usually at the lower of a discounted price and a valuation cap price.
• Interest, maturity, and creditor priority are what separate a note from a SAFE, giving noteholders extra shares and extra leverage.
• Common terms run 15 to 25 percent discounts and about 4 to 8 percent interest (Cooley GO, Vela Wood), with 12 to 24 month maturities (J.P. Morgan).
• Notes are now a small slice of the market: a record-low 7 percent of pre-seed rounds in Carta's Q1 2026 data.
• One sensible approach is to diligence a note as if you were buying stock at the cap, model conversion below, at, and above it, and read the qualified financing, maturity, and change of control terms.

Frequently asked questions

What is a convertible note?

A convertible note is a short-term loan to a startup that converts into equity, usually preferred stock, when the company raises its next priced round. The investor typically receives a discount to that round's price, a valuation cap, or both, and interest accrues and converts along with the principal instead of being paid in cash.

How do you calculate convertible note conversion shares?

Add accrued interest to the principal, then divide by the conversion price, which is the lower of the discounted round price and the cap price. For example, $107,500 of principal and interest converting at a $0.60 cap price produces 179,166 shares, versus 134,375 shares at the $0.80 discount price.

How does a valuation cap work on a convertible note?

The valuation cap sets the maximum company valuation used to calculate the note's conversion price. If the next round values the company above the cap, the note converts as if the valuation were the cap, so the noteholder gets more shares than a new investor receives for the same money. If the round prices below the cap, the cap has no effect.

What is a typical interest rate on a convertible note?

Cooley GO says 6 to 10 percent used to be typical and rates around 4 percent have become more common for early-stage notes, while Vela Wood Law reports typically seeing 6 to 8 percent. Interest usually accrues as simple interest and converts into shares alongside the principal rather than being paid in cash.

What happens when a convertible note matures?

If no qualified financing has closed by the maturity date, the note's terms decide: repayment of principal and interest, conversion at a pre-agreed price, or an extension agreed with noteholders. Cooley GO notes that companies and investors often agree to extend or leave notes outstanding, so it can help to negotiate the maturity outcome before signing.

Sources

• Cooley GO: Primer on Convertible Debt
• Y Combinator: Post-Money Safe User Guide (v1.2)
• Investor.gov (SEC): Rule 506 of Regulation D
• Carta: State of Pre-Seed, Q1 2026
• Carta: State of Pre-Seed, Q2 2026
• Carta: State of Pre-Seed, 2025 in Review
• J.P. Morgan: How Convertible Notes Work for Startups
• Vela Wood: The Basics of Convertible Notes