Procedure · Convertible debt
How to issue convertible notes
A convertible note is debt that converts to equity on a triggering event, with interest accruing in the meantime and a maturity date that forces a decision if no conversion occurs. The procedure runs through term-setting, board authorization, securities-law compliance, issuance and payment, ledger entry, and ongoing monitoring of maturity, interest, and conversion triggers.
Quick facts
Convertible note issuance
| When | For deferred-valuation financings, cross-border investments, or markets where SAFEs are less common |
|---|---|
| Authorized by | The board, under the corporation statute's borrowing authority |
| Key terms | Principal, interest, maturity, cap, discount, qualified financing threshold |
| Records | Note purchase agreement, signed notes, note ledger, board resolution, securities filings |
At a glance
- Convertible notes are debt with a conversion right; SAFEs are forward equity contracts
- Standard terms: principal, interest 2 to 8%, maturity 18 to 36 months, cap, discount
- Securities-law exemption (Rule 506, NI 45-106, FSMA) must be confirmed before closing
- Notes are tracked in the note ledger as outstanding debt; not on the cap table as issued equity
- Maturity forces a decision: convert, repay, or amend
On this page
Steps
Decide whether a convertible note is the right instrument
Convertible notes are debt that converts to equity on a triggering event (typically a priced round, maturity, or change of control). Compared to SAFEs, they have interest, a maturity date, and creditor rights; compared to priced rounds, they defer the valuation negotiation. They are common in jurisdictions where SAFEs are less established (Canada, UK) and in cross-border investments. The choice between SAFE, convertible note, and priced round is a strategic decision based on speed, valuation flexibility, investor preference, and tax considerations. See how to raise on SAFEs for the SAFE alternative.Set the note terms
Standard convertible note terms include the principal amount, the interest rate (typically 2% to 8% per annum), the maturity date (typically 18 to 36 months from issuance), the valuation cap, the discount rate on the qualified financing price (typically 10% to 25%), the qualified financing threshold (the minimum new investment that triggers conversion), the prepayment terms, the events of default, and the treatment on maturity and on liquidity events. Investor rights agreements (most-favoured-nation, pro-rata rights) may also be incorporated.Pass the board resolution authorizing the issuance
The board passes a resolution authorizing the issuance of the convertible note (or a series of notes if multiple investors are participating), approving the form of note and any ancillary documents (note purchase agreement, investor rights agreement), authorizing the officers to execute, and confirming the corporation's compliance with applicable securities-law exemptions. The resolution typically sets the aggregate principal amount the corporation may issue under the authorization. See how to pass a board resolution.Confirm securities-law compliance and accredited-investor status
For US issuers, convertible note issuances rely on a securities-law exemption: Rule 506(b) (no general solicitation, up to 35 non-accredited investors with information), Rule 506(c) (general solicitation permitted but all investors must be verified accredited), Section 4(a)(2), or Section 3(a)(11) intrastate offering. For Canadian issuers, NI 45-106 exemptions (accredited investor, family/friends/business associates, $150,000 minimum). For UK issuers, the Financial Promotion exemption framework under FSMA 2000 (section 21 exemptions). Each investor's status is documented before closing.Execute the note purchase agreement and issue the notes
The corporation and each investor execute a note purchase agreement (which contains the representations, warranties, and ancillary terms) and the corporation issues the note (or notes) to each investor. The note is signed by an authorized officer, dated, and delivered. The investor pays the principal amount on closing; the corporation typically receives funds by wire transfer.Record the note in the note ledger and report the issuance
Each note is recorded in the convertible-note ledger: investor name, principal amount, issuance date, interest rate, maturity date, cap, discount, and reference to the authorizing board resolution. The cap table treats outstanding notes as a separate line (debt with a conversion right, not issued equity until conversion). US issuers file Form D with the SEC within 15 days of the first sale; equivalent filings in Canada (Form 45-106F1) and the UK (no general filing for private placements; FCA reporting only in specific cases).Monitor maturity, interest accrual, and conversion triggers
The note ledger tracks interest accrual against each note's terms. Maturity is monitored against the calendar: at maturity, the note either converts (if a qualified financing or other conversion event has occurred), is repaid (with accrued interest), or is amended. Conversion events (qualified financings, change of control) trigger the conversion math; see how to convert a SAFE for the conceptual mechanics, with adjustments for interest accrual and any note-specific terms (mandatory vs optional conversion).
Jurisdiction notes
Convertible notes are governed by both corporation-statute issuance rules and securities-law exemption frameworks:
- Delaware (DGCL). Convertible notes issued under the corporation's general borrowing authority (DGCL § 122(13)); no specific filings required for the note issuance itself. SEC Form D filing under Rule 503 within 15 days of first sale if Regulation D exemption is used. Original Issue Discount rules under IRC §§ 1271 to 1275 apply if interest is below the applicable federal rate. View jurisdiction guide
- California. Note issuance under general corporate authority. California state-securities filing under Section 25102(f) if not pre-empted by NSMIA. State-level usury rules under California Civil Code §§ 1916 to 1923; exemption for loans to corporations of $300,000 or more. View jurisdiction guide
- Canada (CBCA). Note issuance under general corporate authority. Securities-law exemption under NI 45-106 (accredited investor, $150,000 minimum, family/friends/business associates, offering memorandum); Form 45-106F1 filing within 10 days of the distribution. Canadian Criminal Code s. 347 caps annual interest at 60%. View jurisdiction guide
- Ontario (OBCA). Note issuance under general corporate authority. Ontario Securities Act compliance through NI 45-106 exemptions; Form 45-106F1 filing with the OSC. View jurisdiction guide
- United Kingdom. Note issuance under corporate authority; share allotment authority not required for a debt instrument. Financial Promotion rules under FSMA 2000 s. 21 require an exemption (typically the High Net Worth Individual or Sophisticated Investor exemption). EIS/SEIS schemes cannot be used for convertible loan notes (Advance Subscription Agreements are the EIS-friendly variant). View jurisdiction guide
Common mistakes
- Convertible note treated as equity on the cap table. The corporation issues a convertible note and adds the investor to the cap table as a shareholder. The investor is a creditor, not a shareholder; they have no voting rights, no dividend rights, no share register entry. The cap table is wrong by construction.
- Maturity ignored. The note matures and the corporation has not raised a priced round. Nobody flags the maturity. The note is now technically in default; the investor has creditor remedies. The corporation negotiates an extension or conversion in distress instead of in advance.
- Interest not tracked. The note accrues interest but the ledger doesn't track it. At conversion or repayment, the accrued interest is approximated or estimated, and the investor and the corporation disagree on the figure.
- Securities-law exemption missed. The note is issued to an unaccredited investor without confirming an exemption that permits non-accredited participation. The issuance is a securities violation; the investor has a rescission right.
- OID not considered. A US-issued note with an interest rate below the applicable federal rate has imputed interest under IRC § 1274. The corporation has phantom interest expense and the investor has phantom interest income, both reportable annually. Neither party is aware until tax-return preparation.
In Octelligence
Notes tracked from issuance to conversion or repayment.
Octelligence maintains the convertible-note ledger with principal, interest accrual, cap, discount, maturity, and conversion triggers for each note. The cap table shows outstanding notes as a separate layer; the maturity dashboard surfaces upcoming deadlines well in advance; and conversion math runs automatically when a qualified financing closes.
See Cap Tables & FinancingFAQ
Common questions
A convertible note is debt: it has a principal amount, an interest rate, a maturity date, and creditor rights in a default scenario. A SAFE is a forward contract to issue shares: it has no interest, no maturity, and no debt characteristics. Convertible notes are more common in Canada, the UK, and other non-US jurisdictions, and in cross-border investments. SAFEs dominate US early-stage financings. The conversion mechanics are similar but not identical: notes typically convert into a separate Note Preferred class or sub-series, while SAFEs convert into the new round's preferred or a Safe Preferred sub-series.
The note must be repaid in cash (principal plus accrued interest), converted into equity at a default conversion rate set in the note (often based on the valuation cap), or extended by amendment. The note terms specify which result applies by default; investors and the corporation often negotiate amendments in the run-up to maturity to extend the term or convert at agreed terms rather than trigger repayment that the corporation cannot afford.
Potentially yes, depending on the rate and the jurisdiction. Convertible note interest rates are typically modest (2% to 8%) precisely to stay well below usury caps. State-level usury laws in the US can apply to convertible notes issued to natural persons (corporate borrowers often have higher caps or different rules); Canadian Criminal Code s. 347 caps annual interest at 60% (likely not an issue for typical notes); UK has no statutory usury rate but unfair-contract-term rules can apply. The note should specify the interest rate as a per annum rate, calculated on the basis of a 365-day year, accruing daily.
In the US, registration under the Securities Act of 1933 is required unless an exemption applies. The exemptions used for convertible notes are the same as for other private placements: Rule 506(b) and 506(c) are the most common; Section 4(a)(2) for private offerings; Regulation A for limited public offerings. State blue-sky filings are typically required even when federal registration is exempt. Outside the US, equivalent exemption frameworks apply (NI 45-106 in Canada; the FCA framework in the UK).
Each note converts on its own terms. Some notes may have an MFN (most-favoured-nation) clause that allows the noteholder to elect into more favourable terms in later notes. The conversion math is per-note: each note's outstanding principal plus accrued interest is divided by the conversion price for that note (the lower of the cap-implied price and the discount price), producing a share count. Aggregate dilution is the sum across all notes; individual ownership reflects each note's specific terms.
Generally no on issuance: the investor lends cash and receives a debt instrument of equivalent value. Original issue discount (OID) rules may apply in the US if the note has below-market interest or specific features; the OID is treated as taxable interest to the investor over the note's life. On conversion, the conversion is typically a tax-deferred reorganization (US IRC §§ 354, 368; Canadian ITA s. 51), but the analysis depends on the note's terms and the converted instrument. Repayment in cash at maturity is the return of principal plus interest, with interest taxed as ordinary income.
Notes tracked through every stage
Issuance, interest accrual, conversion, and repayment in one ledger.
Every note's principal, interest, cap, and discount tied to the authorizing resolution and the closing documents, with conversion math running on the next priced round.