Convertible Notes: Debt Or Equity? A Guide For Australian Startups

If you’re building a startup in Australia, raising money is often one of the biggest (and most time-sensitive) hurdles you’ll face. You might have early traction, a great team, or a product that’s ready to scale - but you’re not quite ready for a full equity round with a valuation, investor rights, and a detailed shareholders agreement.

This is where convertible notes tend to enter the conversation.

Convertible notes can be an efficient way to bring in early capital, but they can also cause confusion: are convertible notes debt or equity? The short answer is that they usually start as debt and can later convert into equity - but the practical reality depends heavily on how the note is drafted, what events trigger conversion, and what happens if things don’t go to plan.

In this guide, we’ll walk you through the “debt vs equity” question in plain English, explain the key terms you’ll likely negotiate, and highlight the legal documents and decisions you should have sorted before signing anything.

So, Are Convertible Notes Debt Or Equity?

The most accurate way to think about whether convertible notes are debt or equity is this:

• At the start: a convertible note is generally debt (a loan from the investor to your company).
• Later on: it can become equity (shares in your company) if certain events happen, like a future funding round.

That “convertible” feature is what makes it attractive for many early-stage raises: you can bring money in now without immediately locking in a valuation or issuing shares today.

Why It’s Treated As Debt First

A typical convertible note includes classic “loan-like” features:

• a principal amount (the money invested)
• an interest rate (which may accrue and convert too)
• a maturity date (when it becomes repayable if it hasn’t converted)
• events of default (what happens if the company doesn’t meet obligations)

Because of these features, it’s commonly treated as a liability until it converts (or is repaid) - but the accounting treatment can vary depending on the terms and your circumstances, so it’s worth confirming with your accountant.

How It Becomes Equity

The note usually converts into shares when a “conversion event” occurs. Common conversion events include:

• a priced equity round (e.g. Seed or Series A)
• a sale of the company (exit event)
• sometimes, conversion at maturity (depending on the drafting)

When conversion happens, the investor is no longer a lender - they become a shareholder, with the rights that come with the relevant share class and investment documents.

Why Startups Use Convertible Notes (And When They Can Backfire)

Convertible notes are popular with Australian startups because they can be faster and simpler than a full equity round - but “simpler” doesn’t mean “risk-free”.

Common Reasons Founders Choose Convertible Notes

• Speed: they can be quicker to negotiate than a full share subscription with a lengthy set of investor rights.
• Valuation deferral: you don’t need to agree a valuation today; the conversion price is typically set later, based on the next round.
• Lower upfront cost: they often involve fewer documents than an equity round (though you still want them drafted properly).
• Early momentum: they can help you bridge the gap to a priced round when you have more data, traction, and negotiating power.

Where Convertible Notes Can Create Problems

Convertible notes can become complicated (and sometimes contentious) when:

• you don’t raise another round before maturity
• the discount/cap creates unexpected dilution
• there are multiple notes with inconsistent terms
• the conversion mechanics are unclear
• you raise money without proper approvals or company governance in place

If you’re thinking “we’ll just sort that out later,” it’s worth pausing. Convertible notes are often used early, when everything is moving fast - but that’s exactly when clarity matters most.

Key Terms That Decide How “Debt Or Equity” A Convertible Note Really Feels

Two convertible notes can look similar on the surface but behave very differently in practice. Below are the main terms that shape whether the note feels more like debt (repayment risk, lender leverage) or equity (ownership risk, upside participation).

1. Interest Rate

Interest is a debt feature. Some notes have modest interest that accrues and converts into equity at the same time as the principal.

Even if the interest rate is low, it still impacts:

• your cap table at conversion (more shares may be issued)
• the amount potentially repayable if the note doesn’t convert

Because interest and conversion can also have tax and accounting implications, it’s a good idea to speak with your accountant about how the note is likely to be treated in your specific circumstances.

2. Maturity Date (And What Happens At Maturity)

The maturity date is a big reason why the “convertible notes: debt or equity” debate matters. If there’s a maturity date and the note hasn’t converted by then, the question becomes: is the company required to repay?

Some notes say:

• the company must repay on maturity (strong “debt” feel), or
• the investor can choose repayment or conversion, or
• the note automatically converts at maturity (more “equity” feel, but only if the conversion price mechanics are clear).

From a founder perspective, you’ll want to be very clear about the maturity outcome. A maturity date that effectively forces repayment can become a serious problem if your startup is not cash-flow positive yet.

3. Conversion Trigger (Usually A Priced Round)

Most notes convert when you raise a “qualified financing” - typically meaning a priced equity round above a certain minimum amount.

This protects investors from converting into equity too early (for example, if you raise a small friends-and-family round) but it also means you need to understand what counts as a qualified financing under your document.

4. Discount

A discount means the noteholder converts at a lower price per share than the new investors in the priced round (e.g. 20% off).

This is one of the ways noteholders are compensated for investing early.

5. Valuation Cap

A valuation cap sets the maximum valuation at which the note converts, regardless of the valuation in your next round.

From a founder perspective, caps can be useful for getting a deal done - but they can also lead to heavier dilution than expected if your next round valuation is much higher than the cap.

It’s worth modelling the dilution impact early, especially if you’re raising multiple notes over time. Your accountant or cap table provider can help you sanity-check different scenarios.

6. Repayment, Security, And Default Terms

This is where convertible notes can start to look more like traditional debt.

Key questions to clarify include:

• Is the note secured or unsecured?
• Are there any personal guarantees (generally something founders try to avoid)?
• What counts as an “event of default”?
• What rights does the investor have if there is a default?

If there is security involved, your investor may want to protect their position by registering a security interest on the PPSR, depending on the structure of the deal.

What Should Australian Founders Prepare Before Issuing Convertible Notes?

Because convertible notes often happen early, founders sometimes raise money before the legal foundation of the business is properly set up. That can make the note raise harder, slower, and riskier than it needs to be.

Here are the practical items to check before you sign anything.

Make Sure Your Company Structure And Governance Are Ready

Most convertible notes are issued by a proprietary limited company. If you’re raising investment into a company, you should be clear on how your company is governed and what approvals are required to issue the note and later issue shares on conversion.

Depending on your setup, this may involve reviewing your Company Constitution and any shareholder arrangements already in place.

Get Alignment Between Co-Founders Early

If you have more than one founder, fundraising tends to expose any uncertainty about decision-making, roles, and ownership.

Before you raise on convertible notes, it’s worth getting your key founder terms documented, especially around:

• who can approve fundraising
• what happens if a founder leaves
• how future dilution is handled
• how big decisions are made

Many startups formalise this with a Shareholders Agreement (or put the basics in place now and refine later when investors come in).

Protect Your IP (Because That’s Usually What Investors Are Backing)

For many startups, the most valuable asset is intellectual property (IP): code, product designs, brand, processes, and know-how.

Investors will often want comfort that:

• your company owns (or properly licenses) the IP
• developers/contractors have assigned IP to the company
• there are confidentiality protections in place

When you’re discussing sensitive information with potential investors, an NDA can help set clear confidentiality expectations (even though many investors won’t sign them, it’s still a useful tool in many commercial discussions).

Think Ahead To Your Next Equity Round

Convertible notes are usually a bridge to a priced round. That means you should consider how the note will “fit” with your future fundraising documents.

Ask yourself:

• Will your next round likely involve a new share class?
• Will noteholders convert into ordinary shares or preference shares?
• Will new investors require certain warranties, controls, or veto rights?

Even if you can’t answer every detail today, your convertible note should avoid creating a structure that makes the next round painful.

Legal Documents You’ll Likely Need For A Convertible Note Raise

Convertible notes might be “simpler than equity” - but there are still documents you should consider to protect your startup and keep everyone on the same page.

Depending on your circumstances, you may need:

• Convertible Note Agreement: the main document setting out the loan amount, interest, maturity date, conversion mechanics, and investor rights.
• Company Constitution: to confirm the company has the right framework for issuing and converting securities, and to help avoid conflicts at conversion.
• Shareholders Agreement: if you have multiple founders (or existing shareholders), this can set rules around decision-making, share transfers, and future funding events.
• IP Assignments: to ensure the company owns core IP developed by founders, employees, and contractors (this is commonly raised during investment due diligence).
• Privacy Policy: if you’re collecting personal information from users/customers (for example via an app, SaaS platform or email list), a Privacy Policy helps you set expectations and support compliance.
• Key Commercial Contracts: customer terms, supplier agreements, or platform terms that show how your business operates and manages risk (these documents often become important as you scale and raise further capital).

Not every startup will need every document at the same time, but having the right foundations in place can make your raise smoother and reduce last-minute legal scrambling.

Key Takeaways

• On the question of whether convertible notes are debt or equity, they are generally debt first (a loan), with the ability to convert into equity later if a conversion event occurs.
• The terms that most affect the practical outcome include the maturity date, conversion triggers, discount, valuation cap, and what happens if the note doesn’t convert.
• Convertible notes can be a fast way to raise early capital, but unclear drafting can create real risk - especially if you don’t raise another round before maturity.
• Before issuing a note, it’s worth checking your company governance, founder alignment, and IP position so you don’t run into avoidable roadblocks during fundraising.
• Key documents often include a Convertible Note Agreement, Company Constitution, Shareholders Agreement, and (where relevant) an NDA and Privacy Policy.

This article is general information only and doesn’t take into account your specific circumstances. It isn’t financial product, tax or accounting advice (including under the Corporations Act/ASIC regime). If you’re considering a convertible note, you should also speak with an accountant or financial adviser about the financial and tax implications.

If you’d like a consultation on raising funds through convertible notes (or you’re not sure whether debt or equity is the better fit for your startup), you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.