Convertible debt is a type of loan that startups and companies issue to investors, which can later be converted into equity (company shares) instead of being repaid in cash. It is commonly used in early-stage startup funding, allowing investors to receive equity at a discounted rate in future financing rounds. Convertible debt typically includes a conversion discount, valuation cap, interest rate, and maturity date.
Why do startups use convertible debt?
Convertible debt helps startups raise capital without setting an initial valuation, delaying equity pricing until a later funding round.
How does convertible debt convert into equity?
It converts when the startup raises a priced equity round at a pre-agreed discount or valuation cap, giving early investors favorable terms.
What is the difference between convertible debt and SAFE notes?
Both convert into equity, but SAFE notes (Simple Agreement for Future Equity) do not accrue interest or have a repayment obligation, making them more startup-friendly.
What happens if a startup fails before the debt converts?
If a startup fails, convertible debt holders may be treated as creditors, meaning they could claim repayment before common shareholders—but often recover little to no money.
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