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A debt instrument that converts into equity at a future priced round, typically at a discount (usually 15–25%) to the next round's price and with a valuation cap that limits the price at which the note converts. Convertible notes are common in Indian early-stage deals because they allow startups to raise money quickly without negotiating a valuation — the valuation is deferred until the next round. The note accrues interest (typically 8–12% per annum) and has a maturity date (usually 18–24 months), though extensions are common. If the startup fails to raise a priced round before maturity, the note may convert at a pre-agreed valuation or become repayable.
A convertible note is a short-term debt instrument that converts into equity at a future priced funding round, typically at a discount to the round's price per share and subject to a valuation cap that limits the maximum price at which the debt converts. Convertible notes are widely used in Indian early-stage deals because they allow startups to raise money quickly without the delay, legal expense, and negotiation complexity of pricing a round. Key terms include: the discount rate (typically 15–25%, meaning the investor receives shares at a price lower than the Series A investors pay), the valuation cap (which sets a maximum pre-money valuation for conversion, rewarding early investors for taking more risk), the interest rate (typically 8–12% per annum, accrued and converted into equity), and the maturity date (usually 18–24 months, after which the note either converts at pre-agreed terms or becomes repayable). Convertible notes are considered debt on the company's balance sheet until conversion. For founders, notes are faster and cheaper to close than priced rounds, but the deferred valuation and conversion mechanics can create complexity in the cap table at the next round. For investors, notes offer downside protection (they are debt until conversion) and upside via the discount and cap.
1. Use convertible notes for speed — they can close in 2–4 weeks vs. 8–16 weeks for a priced round. 2. Negotiate three key terms: discount rate (20% is market), valuation cap (based on what the next round might value the company at), and maturity date (24 months is standard). 3. Keep the documentation simple — standard templates from India Law Practice or law firms like Nishith Desai Associates work well. 4. Ensure all founders and the lead note investor understand the conversion mechanics. 5. At the next priced round, the note automatically converts — your lawyer handles the calculation based on the note terms.
A startup raises ₹50 lakh through a convertible note from an angel network with the following terms: 20% discount to the Series A price, a ₹10 crore valuation cap, 10% annual interest, and a 24-month maturity. Eighteen months later, the startup raises a ₹25 crore Series A at a ₹100 crore pre-money valuation. The note converts at the lower of the discounted price (₹80 crore effective valuation after the 20% discount) or the cap (₹10 crore valuation). Since the cap is lower, the note holders convert at the ₹10 crore valuation — receiving equity worth 10x their investment. The founders benefit because they raised the seed capital quickly without negotiating a valuation when the company had minimal traction.
Convertible notes are the fastest, simplest way to raise early-stage capital when you do not want to negotiate a valuation. The key trade-off is that deferred valuation can create surprises at the next round — model different conversion scenarios so you understand how much equity the note holders will receive.