Convertible Note Generator: A Legal Guide for Startup Funding

As a startup founder seeking early-stage funding, you’ve likely encountered convertible notes as a potential financing option. This powerful investment instrument has become increasingly popular among early-stage companies due to its flexibility and relatively straightforward structure. The Convertible Note Generator tool provides a customizable template to create this critical legal document, but understanding the underlying mechanics and terms is essential for making informed decisions for your company.

What is a Convertible Note?

A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round. Unlike a standard loan where you repay the principal plus interest, convertible notes defer the question of company valuation to a later date, allowing startups to raise capital without setting a specific price per share during the early stages.

The note “converts” into equity shares when certain trigger events occur, most commonly when the company raises a specified amount of capital in a later equity financing (known as a “qualified financing”). This arrangement benefits early-stage companies that may find it challenging to determine an appropriate valuation before demonstrating significant traction.

Why Use Convertible Notes for Your Startup?

Convertible notes offer several advantages for early-stage companies:

Speed and Simplicity

Traditional equity rounds require extensive negotiations on valuation and investor rights, which can take months to finalize. Convertible notes typically involve simpler documentation and defer valuation discussions, allowing you to close funding more quickly with lower legal costs.

Valuation Flexibility

By postponing the formal valuation discussion until your company has more operating history and metrics, convertible notes help avoid potentially undervaluing your company in its earliest stages. This structure gives you time to develop your product and demonstrate traction before committing to a specific valuation.

Investor Incentives

For investors who believe in your company’s potential, convertible notes offer incentives through discounts and valuation caps that reward their early support. These features provide upside potential while mitigating some of the risks associated with early-stage investing.

Bridge Financing

Convertible notes serve as an effective bridge between funding rounds, helping startups extend their runway until they’re ready for a larger priced equity round with more favorable terms.

Key Components of the Convertible Note Generator

The Convertible Note Generator allows you to customize all critical elements of your note. Here’s a breakdown of the key components:

1. Company and Investor Information

The basic details of the parties involved, including legal names, addresses, and the effective date of the note. This establishes the legal entities entering into the agreement and provides necessary contact information.

2. Financing Terms

This section covers the economics of the note:

• Principal Amount: The amount of money being invested
• Interest Rate: The annual rate at which interest accrues (typically 5-8%)
• Maturity Date: When the note comes due if it hasn’t converted
• Interest Payment Method: Whether interest is paid periodically or at conversion/maturity
• Prepayment Rights: Whether the company can repay the note before maturity

3. Conversion Mechanisms

These terms govern how and when the note converts to equity:

• Qualified Financing Threshold: The minimum investment amount that triggers automatic conversion
• Discount Rate: The percentage discount applied to the price per share in the qualifying round
• Valuation Cap: The maximum pre-money valuation used to calculate the conversion price
• Conversion Formula: Whether to use the discount, cap, or whichever results in more shares
• Maturity Conversion Options: What happens if the note reaches maturity without conversion

4. Investor Rights and Protections

Special provisions that protect the investor’s interests:

• Pro Rata Rights: The right to maintain ownership percentage in future rounds
• Information Rights: Access to financial statements and business information
• Most Favored Nation (MFN): Ensures the investor gets the best terms offered to other noteholders
• Change of Control: What happens if the company is acquired before conversion

5. Legal and Administrative Terms

Standard legal provisions that govern the agreement:

• Governing Law: Which state’s laws apply to the agreement
• Dispute Resolution: How disagreements will be handled (arbitration, courts, etc.)
• Amendment Requirements: What percentage of noteholders must approve changes
• Notice Requirements: How formal communications must be delivered

How to Use the Convertible Note Generator Effectively

Step 1: Enter Basic Company and Investor Information

Start by providing accurate legal names and addresses for both the company and investor. The state of incorporation is particularly important as it determines which corporate laws will apply. The effective date is the official start date for the agreement.

Step 2: Define Your Financing Terms

Consider your company’s financial needs and timeline when setting these terms:

• Principal Amount: This should reflect the actual investment being made
• Interest Rate: Market rates typically range from 4-8%; higher rates benefit investors but increase your obligation
• Maturity Date: Typically 18-24 months from issuance; allow enough time to reach your next financing milestone
• Prepayment: Most notes do not allow prepayment since investors are seeking equity conversion, not repayment

Step 3: Select Conversion Terms

These critical terms determine how the investment will convert to equity:

• Qualified Financing Threshold: Set this high enough to ensure a substantial funding round ($1-2 million is common), but not so high that it’s unlikely to be reached
• Discount Rate: Typically 15-25%, offering investors compensation for their early risk
• Valuation Cap: Often the most negotiated term, this should reflect a reasonable upper limit on your company’s near-term valuation

Step 4: Define Special Rights

Balance investor protections with your company’s flexibility:

• Pro Rata Rights: These are standard and reasonable for most investors
• Information Rights: Consider what level of disclosure makes sense for your stage
• MFN Provisions: These protect early investors but may limit your flexibility with later notes

Step 5: Set Legal and Administrative Terms

These should align with your company’s jurisdiction and preferences:

• Governing Law: Typically your state of incorporation
• Dispute Resolution: Arbitration often provides a faster, less expensive resolution process
• Amendment Threshold: A majority requirement provides flexibility while protecting investor interests

Legal Considerations When Using Convertible Notes

Securities Law Compliance

Convertible notes are securities and must comply with federal and state securities laws. Most startups rely on exemptions from registration requirements, but you must follow specific rules to qualify for these exemptions. At minimum, you should:

• Limit offerings to accredited investors unless using specific exemptions that allow non-accredited investors
• Provide adequate disclosure of risks and company information
• File any required notices with the SEC and state securities regulators
• Document investor qualifications and maintain proper records

Corporate Authority

Ensure your company has proper authorization to issue convertible notes:

• Board approval through formal resolutions
• Compliance with your articles of incorporation and bylaws
• Any necessary shareholder approvals

Tax Implications

Convertible notes have tax considerations for both the company and investors:

• Interest may be taxable to the investor even if accrued and not paid
• Companies must properly track accrued interest for tax reporting
• Conversion of debt to equity may have tax consequences that should be planned for

Integration with Future Financings

Consider how convertible notes will integrate with future equity rounds:

• Ensure future equity financing documents account for outstanding notes
• Plan for the dilutive impact of note conversions on your cap table
• Consider how multiple notes with different terms will interact

Practical Tips for Negotiating Convertible Note Terms

Principal Amount and Minimum Investment

Consider setting a minimum investment threshold to limit administrative complexity. For efficiency, you may want to create a single note structure that multiple investors can participate in, rather than creating separate notes for each investor.

Interest Rate

While investors may push for higher rates, remember that accrued interest ultimately converts to more equity. A reasonable rate reflects current market conditions and the company’s risk profile. In 2025, market rates typically range from 4-8% for most startup convertible notes.

Discount Rate vs. Valuation Cap

These are the primary mechanisms that reward early investors:

• A discount directly reduces the share price upon conversion
• A valuation cap sets a maximum company valuation for conversion calculations

Most notes include both provisions, with conversion occurring at whichever calculation is more favorable to the investor. Typical discount rates range from 15-25%, while caps depend entirely on your company’s growth trajectory and market sector.

Maturity Date Extensions

Consider including a provision allowing for extension of the maturity date with mutual consent. This provides flexibility if your funding timeline changes.

Major Decision Rights

Be cautious about granting significant control rights to noteholders. Unlike equity investors who typically receive voting rights proportional to their ownership, noteholders may seek special approval rights for major company decisions that exceed their eventual equity percentage.

Change of Control Provisions

The “2x repayment” provision is fairly standard, giving investors the choice between receiving twice their investment amount or converting to equity in the event of an acquisition before the note converts.

FAQ: Common Questions About Convertible Notes

What happens if we don’t raise a qualified financing before the maturity date?

This depends on the conversion at maturity terms in your note. Options include:

1. Automatic conversion to equity at a predetermined valuation
2. Repayment of principal and interest
3. Conversion at the investor’s discretion
4. Extension of the maturity date

The most founder-friendly option is automatic conversion, but investors often prefer having the choice between conversion and repayment. If repayment is required and you can’t make payment, you’ll need to negotiate an extension or restructuring of the debt.

Can we have different terms for different investors in the same round?

Yes, you can create multiple notes with varying terms. However, this creates complexity and may trigger MFN provisions in existing notes. It’s generally cleaner to keep terms consistent within a single funding round unless there are compelling reasons for differentiation.

How do convertible notes affect my cap table?

Convertible notes don’t immediately appear on your cap table as equity, but you should maintain a “fully-diluted” view that estimates the potential equity impact upon conversion. This helps you understand the true ownership picture when planning future rounds.

What’s the difference between a convertible note and a SAFE?

Simple Agreement for Future Equity (SAFE) instruments serve a similar purpose but aren’t debt instruments. Key differences include:

• SAFEs don’t have interest rates or maturity dates
• SAFEs are simpler documents with fewer negotiable terms
• SAFEs may have different tax and accounting treatments

Both can be effective funding tools, but convertible notes often provide more structure and investor protections.

How many convertible notes can we issue?

There’s no legal limit, but practical considerations include:

• Administrative complexity of managing multiple notes
• Potential dilution from numerous conversions
• Signals to the market about your fundraising strategy

Many startups have a “note round” with multiple investors using the same template, followed later by a priced equity round.

Does issuing convertible notes require state securities filings?

Yes, in most cases. While federal exemptions (like Rule 506 of Regulation D) preempt state registration requirements, you typically still need to file notice forms and pay filing fees in states where your investors reside. Consult with a securities attorney to ensure compliance with all applicable regulations.

Can international investors participate in convertible note rounds?

Yes, but additional considerations apply:

• Securities laws in the investor’s home country
• Potential currency conversion issues
• Tax withholding requirements for interest payments
• Compliance with anti-money laundering regulations

When dealing with international investors, consult with attorneys familiar with cross-border investment structures.

The Convertible Note Generator provides a strong starting point for creating legally sound convertible notes, but the specific terms should reflect your company’s unique circumstances and funding needs. For complex financing situations or when significant capital is involved, consulting with an experienced startup attorney is always advisable. The generator allows you to create a customized document that can then be refined with professional legal input as needed.

Remember that a well-structured convertible note balances your company’s need for capital with reasonable investor protections and prepares the groundwork for future financing rounds. Taking the time to understand and carefully select appropriate terms will serve your startup well as you progress through your funding journey.