The convertible note
Debt that becomes stock: interest, maturity, cap and discount — the same $250,000 as a note instead of a SAFE.
A convertible note is a loan meant to become stock. It accrues interest, has a maturity date, and converts at the next financing — principal plus interest — at the lower of its cap price or its discount price. Many notes state the cap as a pre-money valuation, divided by the shares before the round — not, like a post-money SAFE, by a capitalization that already includes the notes. This lesson models it that way.
One 30-day month at 6% on $250,000, 30/360
| Account | Debit | Credit |
|---|---|---|
| Interest expense | 1,250.00 | |
| Accrued interest | 1,250.00 | |
| Balanced | 1,250.00 | 1,250.00 |
Each month the note is outstanding, its interest accrues. A SAFE never books this.
Convertible note
- Good at
- Familiar to every investor and lender
- Creditor priority if the company fails
- Cap and discount like a SAFE
- Watch for
- Interest adds to the shares issued at conversion
- A maturity date: if no round comes, the holders can demand repayment or renegotiate
- Debt on the balance sheet, with conversion features that may need separate accounting
- Best for
- Investors who want a creditor's position; bridges between priced rounds
SAFE
- Good at
- No interest, no maturity
- Dilution known on signing (post-money cap)
- Watch for
- No creditor priority for the investor
- Usually a liability under ASC 480 anyway
- Best for
- Most pre-seed and seed money today
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 470-20 — Debt with Conversion and Other Options (opens in a new tab)A convertible note is debt until it convertsFree after registration
- ASC 815-15 — Embedded Derivatives (opens in a new tab)When a conversion feature has to be split out of the noteFree after registration
- Background reading — not an authority
- Wikipedia, “Convertible note” (opens in a new tab)Convertible notes, from bonds to seed rounds — backgroundFree to read
The full map is in US GAAP, and where these rules come from.
The words this page teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Convertible noteDebt that converts into stock at a future financing, usually at a discount or a cap, accruing interest until it does — a liability until conversion, with any embedded conversion feature assessed for separate accounting
- Valuation capThe highest valuation a SAFE or note converts at. On YC's post-money SAFE the Safe Price is the cap ÷ Company Capitalization, and the holder takes whichever of that or the round price issues more shares
- Conversion discountA SAFE's or note's right to convert at a percentage below the round price — 20% off a $1.00 round is $0.80 — whichever of the discount price or the cap price is lower wins
See also
- Day count & prorationYear fractions under five day-count conventions, side by side.
- Journal entry for accrued interestAt month-end, debit Interest expense and credit Accrued interest for the interest earned by the lender since the last payment. When the payment is made, debit Accrued interest and credit Cash.
- Convertible noteA loan from an investor that converts into shares at your next priced round, usually with a valuation cap or a discount. Unlike a SAFE it's debt: it accrues interest and has a maturity date.