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A convertible note is a financing instrument used in startup capital raising where an investor lends money to a company and the amount converts into shares when a specified event occurs, typically a future equity funding round. Convertible notes allow companies to raise capital now while deferring valuation until a later funding round.

Convertible notes are one of the most commonly used investment instruments in Australian startup and growth-stage capital raising. They offer a practical way for investors to fund a business now, while deferring the point at which shares are issued. This makes them particularly useful when timing, valuation or next-round planning mean a full equity round isn’t quite right.

This article breaks down the key terms and mechanics founders will encounter in a convertible note. It expands on the high-level overview on startup financing, giving you a deeper understanding of how notes work in practice, what commercial levers matter, and how different terms shape conversion outcomes.

What is a Convertible Note?

Unlike a Simple Agreement for Future Equity (SAFE), a convertible note typically begins as debt. The investor advances funds to the company on the understanding that, rather than being repaid in cash, the amount outstanding may convert into shares when a defined trigger event occurs.

This debt-based structure can provide a measure of downside protection for investors, while giving founders flexibility around timing, valuation and documentation. The note terms determine when conversion occurs, how the conversion price is calculated, and what happens if events such as a future funding round, exit or maturity date arise before conversion.

Because these instruments interact with future funding rounds, businesses often benefit from early advice to ensure the terms align with their broader fundraising strategy. If you’re comparing notes to other instruments such as SAFEs or warrants, you can explore our other deep-dives in this series. If you’d like to talk through whether a convertible note makes sense for your business, our capital raising lawyers regularly advise founders and investors on structuring these instruments. Feel free to reach out to us here.

Convertible Note Key Terms and Mechanics

While every convertible note is drafted a little differently, they typically have a set of core features that determine how the instrument operates in practice. Beyond the standard contractual terms (such as the parties and mechanics of issue), convertible notes typically include a series of commercial provisions that govern when and how the note converts, how investor returns are calculated, and what happens if certain events occur.

In the following sections our capital raising lawyers explain the key commercial terms commonly found in convertible notes and how they influence conversion mechanics and founder dilution.

Convertible Note Conversion Triggers

A conversion trigger is the event that causes the note to convert into shares. The most common triggers include:

• Qualified Financing

“Qualified financing” typically refers to a future equity raise above an agreed threshold (for example, $1 million). Once that threshold is met, the note usually converts automatically into the shares issued in that financing round.

• Exit Event

An “exit event” is typically defined as a sale of the company, an IPO or another liquidity event. In this scenario, the note may convert into shares immediately before completion, or the investor may instead receive a return calculated by reference to the exit price, depending on the terms of the note.

• Maturity Date

The “maturity date” marks the point in time when the note can no longer remain outstanding. If no conversion trigger has occurred by that date, the terms of the note will determine what happens next. This commonly includes automatic conversion, repayment of the outstanding amount, or giving the investor the option to elect conversion or redemption.
We explain how conversion triggers interact with other alternative financing instruments in our overview of convertible notes, SAFEs and warrants.

Convertible Note Valuation Cap

The valuation cap is a key concept in many convertible notes. It sets the maximum valuation at which the note will convert and is designed to protect early investors if the next equity round is priced higher than expected. Importantly, the cap does not determine the company’s valuation; rather, it limits the conversion price so that the investor receives a greater number of shares than they would if conversion occurred solely at the priced round valuation. This mechanism helps ensure early investors are not disadvantaged in a later, higher-valued raise.

Because valuation caps directly influence future dilution, founders often model different scenarios before agreeing to a cap. Capital raising lawyers can help founders stress-test these mechanics and understand how the cap may operate once the next equity round is priced.

Convertible Note Discount

The discount is another key concept found in many convertible notes. It gives the investor the right to convert at a percentage reduction to the price paid by new investors in the next equity round. The discount recognises the additional risk taken by early investors and rewards them accordingly. Depending on the note, the investor may convert at either the discount price or the valuation cap price, whichever provides the better outcome. This mechanism is frequently used to balance early-stage risk with future upside.

Conversion Price

The conversion price is the formula used in the note to determine how many shares the investor receives when the note converts. It is often calculated by applying the valuation cap or discount (or both) to the price per share in the qualifying equity round. Because the conversion price directly affects dilution and investor ownership, it is one of the most important commercial terms in the note that should be reviewed by capital raising lawyers. A clear conversion formula helps both parties understand how the investment will translate into equity at the point of conversion.

Interest on Convertible Notes

Interest is a key feature of many convertible notes and reflects the notes underlying debt structure. Instead of being paid in cash, interest is usually capitalised and added to the principal, with the total amount converting into shares when a trigger event occurs. The rate of interest – whether simple or compounding – can influence dilution, particularly if the note remains on issue for an extended period. While some founder-friendly notes include no interest at all, investors often view interest as a standard component of the risk-return profile of a convertible note.

Maturity Date of Convertible Notes

The maturity date is the point in time when the note can no longer remain outstanding. If no earlier conversion event has occurred, the maturity date determines what happens next under the note. Depending on the agreed terms, the note may:

• convert automatically,
• become repayable, or
• give the investor a choice between conversion and repayment.

Because the maturity outcome can significantly affect cash flow, dilution and negotiation dynamics, the maturity date is a central commercial term for founders to understand and model with their capital raising lawyers.

Most-Favoured Nation (MFN)

Some convertible notes include a “most favoured nation” mechanism, which allows an investor to adopt any more favourable terms offered to later noteholders. This concept is more common in notes raised in multiple tranches, but it is not a feature in every Australian note. Where used, it helps ensure early investors are not disadvantaged by later negotiations. MFN clauses are also used in other contexts (including supply chain contracts) which you can read about here.

Redemption Rights

Redemption rights define the circumstances in which an investor may require repayment rather than conversion. These rights may be available at maturity, following certain adverse events, or at the investor’s election. While redemption rights provide downside protection for investors, they can introduce cash flow pressure for the company if repayment becomes mandatory.

Security and Priority

Some convertible notes are unsecured, meaning the investor ranks alongside other unsecured creditors. Others may grant the investor a security interest over company assets or a priority position on repayment. Secured notes shift the risk allocation and can affect the company’s ability to raise further debt or equity, as later investors may need to negotiate around existing security arrangements, or otherwise they may need to be discharged. The decision to include security is heavily context-dependent and often influenced by the investor’s risk appetite and the company’s stage of growth.

Investor Protections in Convertible Notes

Convertible notes may also include specific investor protections intended to preserve the investor’s position until conversion. These can include:

• information and reporting rights,
• restrictions on issuing additional debt,
• consent requirements for major transactions, or
• limitations on issuing further notes on superior terms.

These protections vary widely depending on the investor profile and the stage of the business. At one end of the spectrum, founder-friendly notes include minimal protections; at the other, institutional investors may negotiate terms that resemble elements of a priced equity round.

How These Concepts Influence the Conversion Outcome

The interaction between conversion triggers, caps, discounts, interest and maturity determines:

• how many shares the investor ultimately receives,
• when the note converts, and
• how much dilution the founders experience.

Features such as MFN mechanisms, redemption rights, security arrangements and investor protections also influence the commercial and dilution outcomes by determining how flexible the note is, how it interacts with later investors, and what happens if circumstances change before conversion.

Understanding how these concepts operate collectively is essential for modelling future ownership, anticipating dilution and ensuring convertible note terms remain workable across multiple investors and funding rounds. When structured carefully, convertible notes can provide an efficient bridge to the next stage of capital raising while maintaining flexibility for founders and investors.

If you are interested in the mechanics of SAFEs and warrants we discuss these in detail in other articles in this series, just check out the links below. You can also learn about the potential tax implications of convertible notes which you can read about more here.