Debt to equity conversion for early investors
An investor lends the company money under a note that carries an interest rate and a maturity date, like ordinary debt. Instead of being repaid in cash, the note is designed to convert into equity, usually at the next qualifying priced round, at a discount to the price paid by new investors, subject to a valuation cap in many cases, unlike a SAFE, which carries no interest.
If the company does not raise a qualifying round before maturity, the note's terms usually specify what happens: conversion at a fixed valuation, repayment (rare in practice for early-stage startups with little cash), or an extension negotiated between the parties.
Critical variables in convertible loan agreements
| Term | What it does |
|---|---|
| Interest rate | Accrues and is typically added to the converting principal, increasing shares received |
| Discount | Percentage reduction to the price per share at the next round |
| Valuation cap | Maximum valuation used for conversion, protecting early investors |
| Maturity date | Date by which the note must convert, be repaid, or be extended |
| Qualifying round threshold | Minimum round size that triggers automatic conversion |
Calculation of interest and discount impact
An investor lends EUR 200,000 via a note with 6% annual interest, a 20% discount, and a EUR 6m cap, maturing in 18 months. After 12 months the company raises a priced Series Seed round at a EUR 9m pre-money valuation. The note's principal plus accrued interest (about EUR 212,000) converts using the cheaper of the capped price (based on EUR 6m) or the discounted price (20% off the EUR 9m round), so it converts at the EUR 6m cap, giving the investor more equity than a new investor paying the round price.
Procedural requirements for European convertible debt
In the Netherlands and Germany, converting a loan into BV or GmbH shares generally requires a notarial deed, adding a procedural step and cost compared to UK or US practice. In the UK, convertible loan notes are straightforward contractually but founders should check whether the structure affects SEIS or EIS eligibility for investors, since those reliefs have specific share and timing requirements.
Convertible note mechanics explained
- Does a convertible note investor get repaid in cash if the company doesn't raise again?
- It depends on the note's terms; many early-stage notes are structured so repayment is unlikely in practice and extension or conversion at a fixed price is more common.
- Is interest on a convertible note paid in cash?
- Usually not before conversion. Interest typically accrues and is added to the principal that converts into shares.
- What is a qualifying round?
- A funding round that meets a minimum size threshold set out in the note, which triggers the note to automatically convert into equity.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.