Convertible note

A convertible note is a hybrid instrument that starts life as a loan but is designed to convert into equity rather than be repaid. It is one of the oldest tools for bridging early-stage startups between idea and their first priced equity round, because it lets both parties defer the difficult question of company valuation until more data is available.

The note carries an interest rate (commonly 8–15% per annum in India) and a maturity date — typically 18 to 24 months. If a qualifying financing event (a priced equity round above a threshold amount) occurs before maturity, the outstanding principal plus accrued interest converts into shares of the new round, usually at a discount of 15–25% to the round price or at a valuation cap, whichever gives the noteholder more shares.

If no qualifying round happens by maturity, the founder faces a choice: repay the note in cash, negotiate an extension, or convert at a negotiated price. This maturity cliff is the key risk distinguishing convertible notes from SAFEs, which carry no such deadline pressure.

In India, convertible notes issued to foreign investors are regulated under FEMA and the Foreign Exchange Management (Non-Debt Instruments) Rules. Startups recognised by DPIIT may issue convertible notes to foreign investors in a single tranche of at least ₹25 lakh, with a mandatory conversion or repayment within five years. Domestic convertible notes have fewer restrictions but must still respect Companies Act rules on interest and repayment.