How Convertible Notes Work

One of the most common methods used to invest in early stage startups is something called a convertible note. A convertible note is a loan that converts into equity after the company has a bit more operating history under its belt and there is more information available to establish a fair price.

Convertible notes are often used for seed rounds (the first investment money taken by a startup) because they delay the difficult task of deciding how much the company is worth to a later point in time when it is easier to do so. How much would you say that 2 software engineers and a prototype is worth? How would that change if there was an MBA on the team? By investing through a convertible note, these decisions can be delayed until a company has a track record of users or customers that make it clearer what a fair price should be.

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