A convertible note template is a fill-in-the-blank promissory note that lets a startup take investor money now and issue shares later, usually when the company closes a priced round like a Series A. The blanks that matter are the parties, the company’s state of incorporation, and four financial terms: valuation cap, discount rate, interest rate, and maturity date. Everything else in the document is boilerplate built around those inputs, but the inputs decide how much of the company the investor ends up owning.
Make Sure You Actually Want a Convertible Note
Before filling anything in, confirm the template matches the deal. Y Combinator’s widely used form is a SAFE (Simple Agreement for Future Equity), not a convertible note. The two instruments solve the same problem but work differently.
A convertible note is debt. It sits on the balance sheet as a liability, accrues interest, and has a maturity date by which it must convert or be repaid. A SAFE is an equity contract with no interest, no maturity date, and no repayment obligation; it stays dormant until a triggering event. SAFEs have become the default for many seed deals because they are simpler and cheaper to draft. Convertible notes stay in use when investors want the protections that come with a debt instrument: a hard deadline for conversion, interest that compounds their eventual share count, and creditor status if the company fails.
If both sides agree on a SAFE, use a SAFE. If the deal is genuinely a note, read on.
Administrative Details
The identification fields look routine and matter more than founders expect. Enter the company’s full legal name exactly as it appears on the filed articles of incorporation. A mismatch between the note and the corporate record can create disputes about whether the debt is enforceable against the right entity. Enter the investor’s full legal name as well, whether that is an individual or an investment vehicle such as an LLC or trust.
The template also asks for the state of incorporation, which determines the body of corporate law that governs the note. Most startups incorporate in Delaware even if they operate elsewhere, so do not default to the office address. Include current mailing addresses for both parties, because the notice provisions route legal communications there. Set an effective date, which is usually the date the investor wires funds and marks the start of the legal obligations between the parties.
The Four Financial Terms
The financial inputs are where the real negotiation happens. These fields control how much of the company the investor ends up owning.
Valuation Cap
The valuation cap sets a ceiling on the price at which the note converts. If the company raises its Series A at a $20 million valuation but the note has a $5 million cap, the note holder’s shares are priced as if the company were worth only $5 million. That gap is the investor’s reward for taking the early risk. Caps for seed-stage companies typically fall between $3 million and $10 million, though the range shifts with market conditions.
Discount Rate
The discount gives the note holder a percentage reduction off the price per share that new investors pay in the next round. A 20% discount on a $1.00 per share Series A price means the note holder converts at $0.80 per share. Discounts typically range from 10% to 25%. Many notes include both a cap and a discount, in which case the investor gets whichever method produces the lower conversion price.
Interest Rate
Because the note is debt, it accrues interest, usually between 2% and 8% per year. The interest almost never gets paid in cash. It rolls into the principal balance and increases the total amount that converts into equity. On a $100,000 note at 5% interest held for 18 months, the converting balance would be roughly $107,500. That extra $7,500 buys additional shares at the conversion price.
Maturity Date
The maturity date is the deadline. If no qualifying conversion event has happened by then, the note comes due. Most templates set maturity at 18 to 24 months from the effective date. The consequences of hitting that date without a round in hand are serious enough to deserve their own section below.
How the Conversion Price Is Calculated
When a qualifying round closes, the template’s formula determines how many shares the note holder receives. The conversion price is the lower of two calculations: the Series A share price reduced by the discount rate, or the share price implied by dividing the valuation cap by the company’s fully diluted share count.
Suppose the company raises a Series A at a $10 million pre-money valuation with 10 million fully diluted shares, putting the Series A price at $1.00 per share. The note has a $5 million cap and a 20% discount.
- Discount method: $1.00 × (1 − 0.20) = $0.80 per share
- Cap method: $5,000,000 ÷ 10,000,000 shares = $0.50 per share
The investor gets the lower price and converts at $0.50 per share. On a $100,000 note, ignoring interest for simplicity, that is 200,000 shares instead of the 100,000 a Series A investor would receive for the same money. The discount method only produces a better deal for the note holder when the Series A valuation stays relatively close to the cap. Once the round valuation meaningfully exceeds the cap, the cap controls.
What Happens at Maturity
Many founders get caught off guard here. If no qualifying financing round closes before the maturity date, the note does not quietly extend. Standard templates give the note holder a choice: demand cash repayment of principal plus accrued interest, or convert the outstanding balance into equity at the valuation cap.
In practice, most investors choose conversion rather than force a cash-strapped startup into default. But the leverage shifts entirely to the investor at maturity, and that leverage often results in unfavorable renegotiation of terms. Founders who see maturity approaching without a round on the horizon should negotiate an extension well before the deadline. Waiting until the note is due leaves no bargaining position.
Optional Protective Clauses
Beyond the core financial terms, several optional clauses show up in templates. Whether they appear in your deal depends on who has more leverage at the table.
Most Favored Nation
An MFN clause lets the note holder adopt any better terms the company offers to later note investors before the next equity round. If you sell a second note with a lower cap or higher discount, the first investor can swap into the new terms. This provision appears most often when the investor accepts an uncapped note but wants insurance against a better deal going to someone who invests later.
Qualified Financing Threshold
The template defines what counts as a “qualified financing” that triggers automatic conversion. This is typically a minimum fundraising amount, often set at one to two times the total principal of all outstanding notes. If the threshold is set at $1 million and the company raises only $500,000 in a priced round, the notes do not automatically convert. Setting this number wrong can leave notes outstanding when you expected them to convert, creating cap table confusion.
Subordination
A subordination clause ranks the note below other creditors if the company fails. This matters most when the company has or plans to take on bank debt or a venture lending facility. Senior lenders almost always require convertible notes to be subordinated, meaning the note holder gets paid only after the bank is made whole. If your template lacks a subordination provision and you later seek a credit facility, the lender will likely require one before closing.
Securities Law Compliance
Selling a convertible note is selling a security. Every sale of a security in the United States must either be registered with the SEC or qualify for an exemption. Nearly all convertible notes rely on Regulation D.
Most startups use Rule 506(b), which prohibits general solicitation but allows sales to an unlimited number of accredited investors and up to 35 non-accredited investors in any 90-day period. Non-accredited investors must be financially sophisticated enough to evaluate the investment’s risks. Rule 506(c) permits general solicitation but requires that every purchaser be accredited and that the company take reasonable steps to verify that status.
The template will include representations where the investor confirms accredited status. Under current SEC rules, a natural person qualifies as accredited with income exceeding $200,000 individually (or $300,000 jointly with a spouse or partner) in each of the prior two years with a reasonable expectation of the same in the current year, or net worth exceeding $1 million excluding the value of their primary residence. The SEC also recognizes holders of certain FINRA licenses, including Series 7, Series 65, and Series 82, as accredited regardless of income or net worth.
Rule 506(d) separately bars a company from using the Regulation D exemption if the company or any “covered person” has a disqualifying event in their background. Covered persons include directors, executive officers, 20% shareholders, and anyone paid to solicit investors. Disqualifying events include criminal convictions related to securities transactions, SEC cease-and-desist orders, disciplinary orders revoking a broker-dealer or investment adviser registration, and certain state regulatory orders based on fraud. The template should include representations from both the company and the investor confirming that no disqualifying events apply. If a covered person has a disqualifying history and the company proceeds without disclosure, the entire offering can lose its exemption, exposing the company to rescission claims from every investor in the round.
Post-Closing Filings
Signing the note and receiving the wire is not the end of the compliance process. Two sets of filings follow.
The company must file a Form D notice with the SEC within 15 days after the first sale of securities in the offering. For convertible notes, the “date of first sale” is the date the first investor becomes irrevocably committed, not necessarily when the wire clears. If the 15th day falls on a weekend or holiday, the deadline moves to the next business day. The SEC does not charge a filing fee for Form D.
Most states require their own notice filing after a Regulation D offering, commonly called a “blue sky” filing. The deadline in most states is 15 days after the first sale to an investor residing in that state, though a few states require pre-sale filings. Each state charges its own fee. You file in every state where an investor resides, not just the state where the company is incorporated. Missing state filings is one of the most common compliance oversights in seed rounds, and some states impose penalties for late filings that exceed the original filing fee.
Tax Points Worth Flagging
Section 163(l) of the Internal Revenue Code disallows interest deductions on corporate debt that is reasonably expected to convert into equity. Since most convertible notes are designed to convert rather than be repaid, the IRS may treat the interest as non-deductible from the start. This will not matter to a pre-revenue startup with no taxable income, but it is worth understanding for companies approaching profitability.
Section 1202 lets investors exclude up to 100% of the gain on sale of qualified small business stock held for at least five years, provided the company is a C corporation with gross assets under $75 million at the time the stock is issued. The catch for note investors: the five-year clock starts when the note converts into stock, not when the money was wired. A note that stays outstanding for two years before converting means the investor needs to hold the resulting shares for five more years after conversion to reach the full exclusion. Investors focused on QSBS should factor this delay into their timeline.
Execution and Record-Keeping
Once both sides agree on terms, the company and investor sign the note. Electronic signatures through platforms like DocuSign are standard and legally valid. Physical counterparts still work if either party prefers them. After execution, the investor wires the principal to the company’s business bank account. Confirmation of the wire marks the moment the note becomes a live obligation.
Record the executed note in the company’s capitalization table immediately. The cap table should reflect principal amount, interest rate, valuation cap, discount rate, and maturity date so that anyone reviewing the ownership structure can model the dilution that conversion will cause. Store a signed copy in the corporate minute book alongside the board resolution authorizing the issuance. Sloppy record-keeping here creates real problems during Series A due diligence, when incoming investors and their lawyers will scrutinize every outstanding obligation.