How the note usually works
Raising money through a convertible note means taking a loan that is expected to turn into equity, usually when the company raises a priced round. The note typically carries interest and a maturity date, and it converts either at a discount to the next round's price or at a price set by a valuation cap, whichever gives the investor more shares. The terms define what counts as a qualifying financing, what happens if the company is sold before conversion, and what happens if maturity arrives with no financing. Because a note is debt, it ranks ahead of equity if the company fails, which is a key difference from a SAFE. These choices can significantly change how ownership is divided later.
Legal issues founders and investors overlook
Convertible notes are securities, so the offering needs an exemption from registration, and federal and state notice filings may be required. Selling to people who are not accredited investors adds disclosure obligations and risk. New York's usury laws can matter, especially for notes with deep discounts or floating conversion prices, because the state's highest court has said a conversion feature may count toward interest in some circumstances. Board and shareholder approvals, the number of authorized shares, and any existing investor rights should be checked before notes are issued. Stacking several rounds of notes on different terms creates complexity that often surfaces only at conversion.
Before signing, and when a note comes due
For founders, we review the note terms against the company's plans, model how conversion would affect the cap table under realistic scenarios, and confirm the paperwork is properly approved. For investors, we look at the protections the note offers and whether its terms match the deal you discussed. When a note reaches maturity without a financing, holders may be able to demand repayment, convert on agreed terms, or negotiate an extension, and those talks go more smoothly when the documents are clear. Bring the note or term sheet, the cap table, and the company's formation documents to the first conversation.
