What is a Convertible Promissory Note?

What is a convertible promissory note? At the most superficial level, it is a debt tool for investors or lenders to give a startup capital. Convertible promissory notes are typically seen at the early stage, seed stage, and pre-seed stage. The note is designed to convert into equity (typically preferred stock) at specified “events” like the next round of equity funding.

There are two types of situations where you will see convertible promissory notes used.First, at these early stages, no one knows what the valuation of a company is. So, they typically have a conversion cap which is the maximum equity value that the investment or the loan converts into in equity if another round comes in. That’s generally what everyone’s planning for with a convertible promissory note. 

Second, there are situations where convertible promissory notes are used for a bridge round where the company is not a superstar so-to-speak, In this instance, the investors will put more money in themselves because the business can not raise capital from outside investors. So they’ll typically use a promissory note, convertible, and often it will convert at the next round. However, we are seeing extensions more and more often for hot companies that want to take on some additional capital from existing investors quickly (so that the founders can avoid doing a real fundraise process).

Convertible promissory notes are straightforward to document. For more information on convertible note terms, you can check out this video

Standard terms in a convertible promissory note:

  • A debt tool for investors or lenders to give a startup capital
  • Seen most in early stages (Pre-Seed, Seed, Series A)
  • Idea is to convert from debt into equity at the next funding round
  • Typically have a conversion cap, which places a maximum valuation that the investors will pay for their shares at conversion
  • Usually has a discount rate, which is a discount to the share price of the priced round that causes the conversion
  • There are times that a convertible promissory note is used for a bridge round

Straightforward tool and easy to document!

Again, promissory notes are a favorite, simple tool for angel investors. It is debt and not equity. So if the company gets sold, the promissory note should get paid back first before management or common holders participate. 

The conversion cap and the discount rates can complicate the capitalization table modeling at the moment when the next financing round happens. We recommend working with an experienced law firm, who can help guide you through this. And it’s important to realize that the greater the number of converts, caps and discounts that your company has the more complicated the conversion process is going to be! 

At the heart of it, a convertible promissory note is something that angel investors and venture capitalists use to invest in startups. It is done in the hopes that a startup changes the world and that the investors have a great return on that investment.

READY TO CONNECT FOR A FREE CONSULTATION?

We are the experts at helping seed/VC-backed Delaware C-Corps with their accounting and finances!

Talk to an experienced accountant, not a generic sales person

 Kruze Consulting
Alex Janeck
 Kruze Consulting
Edith Silva
 Kruze Consulting
Ian Williams
Viz AI

$250M+ VC Funding Raised


"I had a great experience working with Kruze Consulting when we raised Series A. They know what VCs need to see, and how to present a startup’s books and finances. If you are going to raise venture capital, you need experts like Kruze."
Chris Mansi

Chris Mansi

CEO

Startup Venture Capital Assistance

With former venture capitalists on staff, our team is here to help you navigate the fundraising process and manage your board of directors

 Kruze Consulting
Scott Orn
COO | Former VC
 Kruze Consulting
Healy Jones
VP FP&A | Former VC
Pequity

Scale Remote Operations & Team


"Kruze has supported us above and beyond basic accounting needs by ensuring we have everything we need to expand and support our team wherever they may be located"
Zack Fisch

Zack Fisch

Head of Operations & Legal

Clients who have worked with Kruze have collectively raised over $15 billion in VC funding.

We set startups up for fundrising success, and know how to work with the top VCs.

 Kruze Consulting
Vanessa Kruze, CPA
Founder & CEO
Kruze Logo

Experienced team helping you

Our account management team is staffed by CPAs and accountants who have, on average, 11 years of experience.

 Kruze Consulting
Bill Hollowsky, CPA
VP of Accounting Services
 Kruze Consulting
Claudine Vantomme, CPA
Controller
 Kruze Consulting
Morgan Avery
SUT/R&D Sr. Tax Accountant
 Kruze Consulting
Beth Bassler
Controller, CPA
Protara Therapeutics

Grew from a 2-person startup to a NASDAQ listed public company.


"The Kruze team helped us grow from a 2-person startup to a NASDAQ listed public company in 2 years. We wouldn’t have gotten public without Kruze’s support. Anyone thinking of launching a startup should make Vanessa their first call!"
Jesse Shefferman

Jesse Shefferman

CEO

Kruze Logo

Get in Touch

Please help us connect with you

How can we reach you?

Our first response is typically via email, so please check your inbox.

Help us have a productive first consultation by providing some additional information.

What year was your startup incorporated?

What is your stage of funding?

(pick up from the list)

Approximately how much funding have you raised?

(please enter a dollar value such as 5000000)

Help us understand what you are looking for:

(Optional, click the ones you need)

Anything additional that you’d like to share?

Optional - if you’d like to share anything else to help us prepare for our consultation, please let us know. We are also happy to sign an NDA, just let us know.

Important Tax Dates for Startups

  Talk to a leading startup CPA