Startup Convertibles: 18 FAQs (with Real-Life Scenarios)
- Stephanie Pflaum
- Sep 4
- 6 min read
Raising capital as a SaaS founder is never just about the numbers—it’s about timing, control, and survival. Convertible notes are a favorite funding tool because they’re fast, flexible, and keep your startup moving when traction is building but valuation debates feel premature.
Here’s a founder-friendly guide to the most common questions, which we've brought to life with scenarios that might feel a little too familiar.
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Valuation & Conversion FAQs
1. How does the valuation cap work on a convertible note?
Imagine you raise $500K on a $5M valuation cap. A year later, you close a $10M Series A. Your early note investors convert as if the company were valued at $5M, giving them more equity for their risk. The cap is basically their “thank-you discount” for believing in you before the crowd did.
2. Do I need both a valuation cap and a discount?
Not necessarily. A discount of say, 20%, ensures investors pay less than new equity investors. But if the valuation cap already gives them a better deal, the discount might never come into play. Many notes have both—it’s a belt-and-suspenders approach, and only one will be used at the time of conversion. For early investors, having both options can sweeten the deal.
3. How much dilution will this convertible note cause when it converts?
The dilution depends on the size of the note and the terms (valuation cap, discount, interest) compared to the valuation of your next priced round. For example, if you raise a $250K note on a $5M cap and later close a $10M Series A, the note converts as if the company were worth $5M. That means the note investors get about 5% of the company ($250K ÷ $5M). That’s a manageable bite.
The danger comes with note stacking. If you raise multiple notes with different caps (say, $250K at $5M, then $500K at $8M, then another $250K at $10M), the dilution adds up fast. By the time you hit your Series A, you and your co-founders might discover you’ve given away closer to 10–15% of the company before the new investors even come in. That’s why it’s critical to model different scenarios with your cap table before signing notes. A single note can be fine; a pile of them can quietly eat your ownership.
4. At what stage does the note usually convert?
Most often at your next priced round—seed extension, Series A, or even later funding rounds if you bootstrap longer. Until then, it’s essentially a loan waiting to turn into equity.
Note Terms & Investor Expectations
5. What’s the market standard interest rate?
Convertible notes are debt, so they usually accrue 4 to 8% annual interest. But unlike a bank loan, you’re not cutting checks each month—the interest simply adds to the principal and converts into equity when the note converts.
For example: raise a $400K note at 6%. After a year, the note balance grows to $424K. When you close your priced round, that extra $24K converts into shares along with the original $400K. The key point: interest increases the number of shares issued later, slightly increasing dilution, but investors almost always prefer equity upside over repayment in cash.
6. What’s the standard maturity period?
Usually 12–24 months. Think of it as the investor saying, “I expect you’ll raise again within 18 months.” If you don’t raise a qualifying round in that time, you may need an extension; and you may need to do some explaining as to why.
7. Should I add pro rata rights for noteholders?
Pro rata rights give an investor the option to invest in your next priced round so they can maintain their ownership percentage after their note converts. If an angel invests $25K, they probably don't need pro rata rights. But if a fund invests $500K, they’ll likely ask for the chance to double down in your Series A. It’s their way of protecting early ownership.
8. Do investors expect both interest and a discount?
Often, yes. It incentivizes more conservative investors that want downside protection, in addition to upside. Think of it like giving them two ways to win—extra equity from interest and a cheaper price than Series A investors.
Find the right funding strategy for your startup
Most entrepreneurs see venture capital as the holy grail of funding solutions, but fewer than 0.05% of U.S. startups ever raise a VC round.
There are other startup fundraising options, and some might be more advantageous for your business. This guide will help you decide what kind of capital to raise, when to raise it, and what you need to get it.
Trigger & Repayment FAQs
9. What counts as a “qualified financing” that triggers conversion?
Say your convertible note specifies $1M as the threshold. If you raise a $750K bridge, the note doesn’t automatically convert. But if you raise a $2M Series A, the noteholders are in. In other words, qualified financing is your next priced equity round that meets the conversion threshold.
10. What happens if I don’t raise another round before maturity?
Legally, you owe the money back. In reality, most investors don’t want to bankrupt you, so they’ll extend the note or convert into common stock. Just be sure you don’t simply assume they won't want the money and get clarity up front, in writing.
11. Can investors actually demand repayment?
Yes. Will they? Maybe not. Smart investors know pushing for repayment just kills the goose before it lays the golden eggs. But if they do demand repayment and they call the loan, you better be able to pay it or you'll lose your business.
12. What happens if I sell the company before the note converts?
If you sell for $20M, noteholders usually get paid out or convert into equity just before the deal. Some notes even promise them 1 to 2x their investment in this scenario. Read the fine print carefully.
RELATED: The Hidden Trap of Convertible Debt
Comparisons & Alternatives
13. How is a convertible note different from a SAFE?
Think of a convertible note as a loan with an expiration date. A SAFE is like a forever coupon—no interest, no maturity—some even call it convertible equity. Notes have been around longer and are more common with traditional investors; SAFEs are simpler and loved by startup accelerators like YC, as well as many angel investors.
14. When should I use a note instead of a priced round?
If you’re still figuring out your metrics—say, you just hit $30K MRR but don’t have enough traction to justify a strong valuation—a note buys you time. Once you hit $100K MRR, you’re in a better position to price a round. If it's a particularly tough funding market and you aren't sure you'll be able to raise a priced round, even with a note, you might want to keep bootstrapping.
15. Do VCs care if I have too many notes outstanding?
Yes. If you’ve stacked five notes with different caps, your Series A investor will spend half the diligence call trying to untangle your cap table. A clean cap table makes you look more fundable.
Realize your dreams, on your terms.
Since 2010, Lighter Capital has helped SaaS startups grow through more than 1,000 rounds of funding and over $350 million in non-dilutive financing. More than 20% of our portfolio clients have been acquired by companies that include Amazon, Salesforce, and Eventbrite, to name a few.
Complete our secure online application to find out how much you can qualify for.
Fundraising Strategy
16. Is a convertible note just kicking the valuation can down the road?
Yes, and that’s the point. Notes give you speed, flexibility, and capital without the dilution right now. Punting valuation discussions to your Series A, buys you time to get the valuation you think you deserve—and hopefully you'll have the corresponding metrics by then to back it up.
Try our valuation calculator to model different scenarios and see what your startup could be worth.
17. How do I avoid “note stacking”?
Raise once, raise what you need, and keep terms consistent. Three small overlapping notes are a headache; one clear note round is a story your Series A investor can follow.
18. What legal pitfalls should I watch out for?
Keep in mind that good legal review costs less than fixing a bad note later, and watch out for the following:
Notes with aggressive repayment clauses
Conversion triggers that sneak in at low amounts
Valuation caps so low they wipe out your equity
The Bottom Line on Convertibles
Convertible notes aren’t “free money.” They’re a bridge to help you reach the milestones (ARR, churn improvements, enterprise logos) that justify a strong priced equity round later.
Done right, convertibles keep your runway smooth and your ownership intact. Done wrong, they create dilution surprises and messy fundraising negotiations down the road.
Raise with clarity, keep it clean, and remember: every shortcut in fundraising has a price tag.
