A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round. In effect, the investor loans money to a startup and instead of a return in the form of principal plus interest, they receive equity in the company. One advantage of issuing convertible notes is that it does not force the issuer and investors to assign a specific value to the company at a stage where insufficient information is available. The valuation will usually be determined during a qualified financing event (typically a follow-on round) when there are more data-points off which to base a valuation. In addition, convertible notes can be cheaper and quicker to an issue than preferred stock due to lesser legal costs.
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