I’m going to say something that might get me kicked out of the Silicon Valley club. Most of what you’ve heard about convertible notes is wrong. Dead wrong.
For ten years, I’ve been on both sides of the table. As a founder, I raised millions using these things for my first company, MovieLaLa, and later for RemoteTeam. As an angel investor in over 200 companies—including some you definitely know, like Anthropic, Scale AI, and Hugging Face—I’ve seen them from the other side. I’ve seen them used brilliantly, and I’ve seen them absolutely destroy a startup before it even had a chance.
People talk about convertible notes as if they’re some magic bullet for fundraising. "It’s faster!" "You don’t need a valuation!" "It’s simple!"
Simple? Simple like a landmine. One wrong step and your cap table is a crater.
Let’s be real. The reason everyone pushes convertible notes is because they delay the hard conversation: what is your company actually worth? It’s a form of procrastination. And in the startup world, procrastination is a death sentence.
The Big Lie About Valuation
The number one reason founders tell me they’re using a convertible note is to avoid pricing their round. I get it. Valuation is hard. It feels like you’re pulling a number out of thin air. You’re terrified of giving away too much of your company for too little cash.
So you kick the can down the road. You take a check from an investor, sign a note, and agree to figure out the equity later. But you’re not avoiding the valuation problem. You’re just amplifying it.
Here’s what happens. You raise a $500,000 convertible note with a 20% discount and a $5 million valuation cap. You feel great. You have cash in the bank. You’re building your product. Life is good.
A year later, you’ve made some progress. You’ve got a product, some early customers. You’re ready to raise a real round of funding, a Series A. A VC comes along and says, "I love what you’re doing. I’ll invest $2 million at a $10 million pre-money valuation."
Amazing, right? You’re a genius! Your company is worth $10 million!
Not so fast. Remember that $500,000 note? It’s about to convert. And because you hit that $10 million valuation, which is higher than your $5 million cap, your early investor gets to convert their debt into equity at the cap price.
So, that $500,000? It doesn’t convert at the $10 million valuation your new VC is paying. It converts at the $5 million cap you agreed to a year ago. That means your early investor is getting twice as much stock as the new investor for the same price. They get to buy shares for $0.50 while your new VC is paying $1.00.
And that 20% discount? That’s usually a either/or scenario with the cap. The investor gets whichever is better for them. In this case, the cap is way better.
This is where things get messy. Your new VC sees this and says, "Wait a minute. This early investor is getting a sweetheart deal. That’s diluting my ownership. I’m not okay with this."
Now you’re stuck. You have to renegotiate with your early investor, your new investor, or both. Your fundraising process grinds to a halt. Your momentum is gone. And you’re burning through that cash you raised faster than you think.
I saw this happen to a founder I know. Great product, great team. They raised a convertible note with a low cap to get some early cash. When they went to raise their Series A, the VCs balked. The note holders were getting such a good deal that it made the round unattractive for new money. The company limped along for a few more months and then died. All because of a "simple" convertible note.
My Playbook for Convertible Notes
So, am I saying you should never use convertible notes? No. They can be a useful tool in the right situation. But you have to be smart about it. You have to go in with your eyes wide open.
Here’s my playbook for using convertible notes without blowing up your company.
Only use them for your first small round. I’m talking about your "friends and family" round. The first $50,000 to $100,000 you raise to get the idea off the ground. At this stage, it’s really hard to put a valuation on the company. A convertible note is a reasonable way to get some cash in the door without spending weeks arguing about valuation.
Set a reasonable cap. The valuation cap is the most important term in a convertible note. It sets the maximum price that the investor’s money will convert into equity. If you set the cap too low, you’re giving away a huge chunk of your company for a small amount of cash. If you set it too high, you might have trouble raising your next round.
So what’s a reasonable cap? It depends on your stage, your team, your market. But as a general rule of thumb, for a pre-seed round, I like to see caps in the $3 million to $8 million range. If you’re a first-time founder with just an idea, you’re going to be on the lower end of that range. If you’re a second-time founder with a track record and a prototype, you can command a higher cap.
Don’t give away a huge discount. The discount is the other key term. It gives the investor a discount on the price of the stock when the note converts. A typical discount is 15-25%. Anything more than that and you’re giving away too much.
Remember, the investor is already being compensated for their risk with the valuation cap. The discount is just a little sweetener. Don’t let it become the main course.
Keep the interest rate low. Most convertible notes have an interest rate. This is because they are technically debt instruments. The interest accrues and is added to the principal when the note converts. I’ve seen rates as high as 8% or 10%. That’s insane. You’re not a bank. You’re a startup. You should be using that money to build your business, not to pay interest to your investors.
I push for a 2-4% interest rate. Anything higher is a red flag for me.
Have a maturity date. A maturity date is the date when the note is due. If you haven’t raised a priced round by the maturity date, the note holder can demand their money back, plus interest. Or, they can convert their debt into equity at the valuation cap.
A typical maturity date is 18-24 months. This gives you enough time to make some progress and raise a Series A. But it also puts some pressure on you to perform. It’s a good forcing function.
The SAFE Alternative
In the last few years, a new alternative to convertible notes has emerged: the SAFE.
SAFE stands for Simple Agreement for Future Equity. It was created by Y Combinator, and it’s become the standard for early-stage fundraising in Silicon Valley.
A SAFE is similar to a convertible note in that it allows you to take an investment without setting a valuation. But there are a few key differences.
First, a SAFE is not debt. It’s a warrant. This means there’s no interest rate and no maturity date. The money just sits on your cap table until you raise a priced round.
Second, SAFEs are… well, simple. They’re typically just a few pages long, and the terms are standardized. This means you can spend less time and money on legal fees.
I’m a big fan of SAFEs. I’ve used them in my own companies, and I’ve invested in dozens of companies that have used them. They’re a much more founder-friendly instrument than convertible notes.
But they’re not perfect. The biggest issue with SAFEs is that they can stack up. You can raise a little money on a SAFE, and then a little more, and then a little more. Before you know it, you’ve sold 20-30% of your company before you’ve even raised a priced round.
This can be a real problem when you go to raise your Series A. VCs will look at your cap table and see a long list of SAFE holders. They’ll have to do the math to figure out how much of the company is already spoken for. And they might not like what they see.
So, my advice on SAFEs is the same as my advice on convertible notes: use them for your first small round, and then move to a priced round as quickly as possible.
Pre-money vs. Post-money SAFEs: A Quick and Dirty Guide
This is a topic that trips up a lot of founders. YC originally released the pre-money SAFE, but now they’ve switched to a post-money SAFE. What’s the difference?
In a nutshell, a pre-money SAFE means the investor’s ownership is calculated before the new money in the priced round comes in. A post-money SAFE means the investor’s ownership is calculated after the new money comes in.
Why does this matter? Because it affects how much dilution you, the founder, will experience.
With a pre-money SAFE, the founder bears all the dilution from the SAFE converting. With a post-money SAFE, the dilution is shared between the founder and the new investors.
Let me give you a quick example.
Let’s say you raise $500,000 on a post-money SAFE with a $5 million valuation cap. When you go to raise your Series A, the SAFE holder will own 10% of the company ($500,000 / $5 million).
Now, let’s say you raise $500,000 on a pre-money SAFE with a $5 million valuation cap. When you raise your Series A, the SAFE holder’s ownership will be calculated based on the pre-money valuation. If a VC invests $2 million at a $10 million pre-money valuation, the post-money valuation is $12 million. The SAFE holder’s ownership is now calculated on a much larger number, so they get a smaller percentage of the company.
As a founder, the post-money SAFE is generally better for you. It gives you more certainty about how much of your company you’re giving away. But you need to understand the difference and model it out. Don’t just sign a SAFE without knowing what you’re getting into.
The Bottom Line
Look, fundraising is hard. It’s a necessary evil. But don’t make it harder than it needs to be.
Don’t get seduced by the siren song of the "easy" convertible note. Understand the terms. Understand the trade-offs. And most importantly, understand what you’re giving away.
Your equity is the most valuable thing you have. Don’t give it away for a song.
Be smart. Be strategic. And for God’s sake, don’t procrastinate on the valuation conversation. Have it early. Have it often. And get it right.
Your company’s future depends on it.
Frequently Asked Questions
What's the most common pushback you get on this?
People often push back by citing exceptions or edge cases. And they're usually right that exceptions exist. But building a strategy around exceptions rather than patterns is a losing game for most founders.
Do all experts agree with this view?
No, and that's fine. The best ideas in business are often contrarian. I share my perspective based on my experience and data, but I encourage you to seek out opposing viewpoints and form your own conclusions.
How can I apply this thinking to my own situation?
Start by identifying the core principle behind the opinion, not the specific example. Then ask yourself: does this principle apply to my context? If yes, test it in a small, low-risk way before going all in.