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Author: Riley Jacobs, Attorney
TLDR: Convertible notes remain a powerful seed financing tool, especially for tech and biotech startups not ready to set a valuation. But before diving into legal documents, founders should focus on negotiating a clear, founder-friendly convertible note term sheet. Though typically non-binding, the term sheet defines key deal terms like the discount rate, valuation cap, maturity date, and interest rate, that shape future dilution, conversion mechanics and investor protections. Getting these terms right can mean the difference between long-term ownership or giving away too much too early. Work with experienced startup counsel to strike the right balance and set your company up for a strong Series A.
Consult with a startup attorney today!
While SAFEs have surged in popularity, convertible note financing remains a crucial alternative for tech and biotech startups seeking to raise seed funding without immediately setting a valuation or relinquishing equity. Sometimes, structuring a seed round as a convertible note rather than a SAFE can help attract seasoned investors or secure a lead investor who prefers more defined investor protections.
But regardless of structure, one document deserves special attention before legal drafting begins: the convertible note term sheet.
Although typically non-binding (except for provisions on confidentiality, expenses and governing law), the convertible note term sheet sets the expectations that will drive the final legal documents and directly impact founder dilution, financial runway, and investor conversion terms. It’s where the business deal gets shaped—and where founders can either preserve or lose substantial long-term equity.
Below, we outline the most essential terms to negotiate in a convertible note term sheet and why each one matters.
Key Terms to Negotiate in a Convertible Note Term Sheet
Aggregate Principal Amount
This term refers to the total capital your startup plans to raise through convertible note financing. Tech and biotech founders should align this figure with their short-term capital requirements while considering the downstream impact.
Raising more money increases the runway, but also increases potential dilution when the notes convert. Each dollar raised must either be paid back at maturity or converted into equity, typically at a discount or valuation cap that most favors investors.
Maturity Date
Every convertible note has a maturity date, the point at which the note must either convert or be repaid. A maturity window of 18 to 36 months is commonly used and gives startups time to hit milestones, close a priced equity round, and avoid forced repayment, subject to applicable usury laws.
Because notes are debt instruments, failure to trigger conversion before the maturity date could lead to significant liabilities, including repayment of principal and accrued interest. Working with an experienced startup attorney during this structuring phase can help founders navigate appropriate timelines and avoid unintended consequences.
Discount Rate
Convertible note term sheets typically offer investors a discount rate, usually 10–25%, on the price per share in the next financing. For example, if Series A investors pay $1.00 per share, noteholders with a 20% discount would convert at $0.80 per share.
A higher discount increases investor upside, but it also increases dilution for founders and early team members. Founders negotiating term sheets should weigh the tradeoffs carefully. Often, a moderate discount combined with a higher valuation cap strikes the right balance.
Valuation Cap
The valuation cap places an upper limit on the valuation used for note conversion, ensuring early investors benefit if the startup’s valuation rises significantly before the next round. For instance, if your cap is $10 million but your priced round closes at $20 million, the noteholders will convert at the $10 million valuation, getting twice as much equity per dollar invested.
Most convertible note financings include both a discount and a cap, giving investors a more favorable conversion result. Founders should negotiate for a valuation cap that reflects realistic future valuation potential without handing over excessive equity upfront.
Interest Rate
Although notes are intended to convert, they still accrue interest, typically 5–10% annually, subject to California’s usury law limitations. This interest usually converts into equity along with the principal amount. While more interest means more shares for investors, it’s often less dilutive than a higher discount or lower valuation cap.
In practice, if you must concede ground in negotiations, consider offering a slightly higher interest rate before adjusting the valuation cap or discount. An experienced and finance-focused startup attorney can help model various scenarios to clarify these tradeoffs.
Why the Convertible Note Term Sheet Matters
Although it’s a non-binding document, the convertible note term sheet often becomes the definitive statement of deal terms. “Re-trading” the agreed-upon terms later in negotiations can undermine credibility and delay closing.
That’s why founders must treat the term sheet with the same care they’d give a signed agreement. By capturing all material economic terms at this stage, startups preserve negotiating leverage and avoid downstream surprises.
Working with a law firm that understands the unique pressures of tech and biotech startups is essential. An experienced startup attorney can help you structure your convertible note financing to align with your growth strategy, limit dilution, and protect your company’s long-term interests.
Let’s Talk Strategy
If you’re preparing to raise your first institutional capital, don’t wait until legal documents are drafted to focus on structure. The convertible note term sheet is your financing blueprint and the best opportunity to shape the economics of your funding round.
Reach out to our team to schedule a strategy session. We help founders structure convertible note financings that set the stage for a successful Series A round and beyond.
Clients Also Ask Us:
What is a convertible note term sheet?
A convertible note term sheet is a non-binding document that outlines the key economic terms of a convertible note financing round, helping founders and investors align on deal structure before legal drafting begins.
What are the key terms of a convertible note?
Key terms include:
- Aggregate Principal Amount (total raised)
- Maturity Date (repayment or conversion deadline)
- Discount Rate (conversion discount to next round)
- Valuation Cap (maximum valuation for conversion)
- Interest Rate (typically 5–10% annually)
Check out this blog for a deeper dive into the key terms of convertible note term sheets.
What is the key difference between a convertible note and a SAFE?
A convertible note is a debt instrument with a maturity date and interest. In contrast, a SAFE is not a debt instrument and has no maturity or repayment obligation, making notes potentially riskier for founders if they don’t convert.
How does convertible debt work?
Convertible debt starts as a loan to the company and later converts into equity, usually at a discount or valuation cap, when the company raises its next priced financing round.
