Convertible Notes in Australia: What Startups Should Know

Raising capital is one of the biggest hurdles for growing a small business or startup in Australia. If you’re not ready to set a valuation or you want a faster, more flexible way to bring investors on board, a convertible note could be the right fit.

In this guide, we’ll break down what a convertible note is, how it works, and the key legal and commercial points to get right in Australia. We’ll also walk through a practical step-by-step process so you can raise funds with confidence.

What Is A Convertible Note (And Why Do Australian Startups Use Them)?

A convertible note is a short-term loan that can convert into shares in your company later, usually at your next equity round or a defined trigger event.

Instead of setting a valuation today, you agree on conversion mechanics (like a discount and/or valuation cap) so that when you do a priced round later, the note amount converts into equity on pre-agreed terms.

Australian founders like convertible notes because they’re faster to issue than a full equity round, let you delay valuation discussions until there’s more traction, and can be tailored to suit your growth plans.

How Does A Convertible Note Work?

While every deal is different, most notes share a common set of terms. Understanding these will help you negotiate a fair and balanced note for your business and investors.

Core Mechanics

• Principal: The amount invested under the note (the “loan”).
• Interest: Often a simple interest rate that accrues and usually converts into shares alongside the principal.
• Maturity Date: The date the note must either convert or be repaid (subject to the note’s terms).
• Conversion Trigger: Commonly the next equity round above a minimum size. Other triggers can include a sale of the company or maturity.
• Valuation Cap: A ceiling on the valuation used for conversion, protecting early investors if your valuation skyrockets before the round.
• Discount: A percentage reduction applied to the next round price per share, rewarding early risk (e.g. 15-25%).
• Most Favoured Nation (MFN): A clause giving noteholders the benefit of better terms if you later issue a more favourable note before conversion.

Repayment vs Conversion

Notes can be structured to convert at maturity, repay at maturity, or give investors an option between the two. Many founders prefer mandatory conversion (subject to agreed triggers) to avoid cash strain later.

Security And Ranking

Most early-stage notes are unsecured, but some investors ask for security over assets. If you grant security, expect to register that interest on the PPSR so the priority is clear.

Events Of Default

These are the “what ifs” (e.g. insolvency, serious breaches). Default rights can include acceleration (immediate repayment) or early conversion. Keep defaults reasonable so you’re not tripped up by technicalities.

When Is A Convertible Note The Right Choice?

Convertible notes can be a great fit if:

• You want to move quickly and keep legal costs and paperwork lean compared to a priced equity round.
• You prefer to delay a valuation until you’ve reached a milestone that supports a stronger price.
• You’re bridging to a larger seed/Series A where conversion can neatly occur.
• Investors are comfortable with a cap and discount that reward their early risk.

However, if you already have a clear valuation in mind or investors want voting rights from day one, a priced equity round may be better. A short, non-binding Term Sheet can help you test alignment before drafting long-form documents.

Legal And Compliance Essentials In Australia

Convertible notes sit at the intersection of loan and equity, so it’s important to tick off your Australian legal obligations before you accept funds.

Offers And Disclosures (Corporations Act)

Most early-stage raises rely on disclosure exemptions, especially under Section 708 of the Corporations Act 2001 (Cth). Common pathways include small-scale offerings (the “20 investors/$2 million in 12 months” rule) and offers to sophisticated investors who meet asset/income thresholds.

Make sure you fall within an exemption, and keep records of how each investor qualifies.

Company Documents And Investor Rights

Your foundational documents should line up with your raise. It’s smart to review your Company Constitution and, where relevant, your Shareholders Agreement to ensure there’s no conflict with future conversions (e.g. pre-emptive rights, class rights, consent thresholds).

Board Approvals And Execution

Document board approvals and issue notes using proper execution formalities. Clear resolutions and properly signed agreements reduce headaches later, especially at the conversion round or during due diligence.

Financial Services And Advertising

Avoid public advertising that could be treated as an unlicensed public offering. Keep your approach targeted and aligned with available exemptions.

Tax And Accounting

Notes can raise tax questions around interest, withholding (for non-resident investors), and treatment at conversion. Work with your accountant early to set up processes that align with your note terms.

Key Terms To Negotiate In Your Convertible Note Term Sheet

Most negotiations align around a few levers. A concise Term Sheet helps everyone agree the headline terms before you draft the note itself.

• Cap And Discount: Balance investor upside with founder dilution. A cap “anchors” conversion while a discount rewards early risk.
• Maturity And Interest: Pick realistic timelines and interest mechanics (cash vs PIK/convertible interest).
• Conversion Triggers: Define qualifying financing size, sale/change of control, and what happens at maturity.
• Security: Consider whether the note is unsecured or secured (and if so, over which assets and in what priority).
• Investor Protections: MFN rights, information rights, and limits on additional indebtedness can be calibrated to your stage.
• Company Protections: Avoid overly broad default events or terms that block normal business operations.

Documents You’ll Typically Need

Getting your paperwork right protects you and reassures investors that your business is professionally run.

• Convertible Note: The main agreement setting out principal, interest, conversion mechanics, security (if any), and default terms. If you want support preparing a robust note, Sprintlaw offers a fixed-fee Convertible Note service.
• Term Sheet: A non-binding summary of key commercial terms to align expectations early.
• Board/Shareholder Resolutions: Approvals for issuing notes and, later, for creating new share classes on conversion.
• Company Constitution: Ensure your Company Constitution supports future share issues, classes and conversion mechanics.
• Shareholders Agreement: If you have co-founders or existing investors, your Shareholders Agreement should be consistent with the note and anticipated conversion.
• Cap Table And Conversion Model: A clean cap table and a simple model for different conversion scenarios (cap vs discount) help avoid surprises.
• PPSR Registration: If the note is secured, register the security on the PPSR within the required timeframes.

Common Pitfalls To Avoid

• Kicking Valuation Problems Down The Road: A cap set too high can create friction later; too low can be overly dilutive. Model outcomes before you sign.
• Maturity Mismatch: Picking a maturity date that arrives before your next round can force a cash repayment you didn’t plan for. Build in realistic timelines and extension options.
• Conflicts With Company Documents: If your note terms clash with your existing governance documents, you can end up needing consents at the worst possible time. Align documents early.
• Public Solicitation Risks: Broad advertising can jeopardise your reliance on disclosure exemptions. Keep your raise targeted.
• Unclear Triggers: Vague conversion triggers lead to disputes. Define qualifying financing and sale/change of control clearly.
• Overly Aggressive Defaults: Technical defaults can give investors leverage at inopportune times. Keep default events focused on serious risk.

Step-By-Step: Raising With A Convertible Note

1) Map Your Raise

Decide your target amount, timeline, and who you’ll approach (e.g. angels who meet sophisticated investors criteria, or a small group under the small-scale offerings exemption). Build a simple conversion model to gauge dilution at different caps/discounts.

2) Align On Headline Terms

Prepare a concise Term Sheet covering valuation cap, discount, maturity, interest, triggers, and security position. This keeps negotiations focused and reduces drafting time.

3) Check Your Company Settings

Review your Company Constitution and any Shareholders Agreement for pre-emptive rights, class creation rules and consent thresholds. If needed, update documents or obtain consents before you issue notes.

4) Confirm Your Exemption

Make sure your offer fits within Section 708 or another applicable pathway, and capture the right certificates or acknowledgements from investors for your records.

5) Draft And Execute The Note

Prepare the note agreement with clear, balanced terms. Have your board approve the issue and execute the documents correctly. Keep a tight record of noteholders and principal/interest balances.

6) Register Security (If Any)

If the note is secured, register the interest promptly on the PPSR. This helps protect priority if anything goes wrong.

7) Maintain Your Cap Table

Track accrued interest, MFN implications, and any subsequent notes so you have a clear view of your ownership at conversion.

8) Plan For Conversion

Before your next round, confirm the conversion price (cap vs discount), prepare new share classes if needed, and line up board/shareholder approvals. If you’re planning employee equity as part of the round, consider how note conversion affects any option pool sizing and your broader ownership model.

How Convertible Notes Compare To Other Funding Tools

Convertible notes are just one way to raise capital. Some founders prefer equity rounds when there’s enough data to justify a valuation. Others lean toward SAFEs due to their simplicity.

Whichever path you choose, it’s worth pressure-testing dilution and governance outcomes early, especially if you’ll later implement employee equity or negotiate more complex investor rights.

Key Takeaways

• A convertible note is a loan that converts to equity later, letting you move fast and delay valuation until your next round.
• Focus negotiations on the cap, discount, maturity, interest, triggers, and whether the note is secured or unsecured.
• Use disclosure exemptions (often Section 708) and keep clear records that each investor qualifies.
• Align your Company Constitution and Shareholders Agreement with your note terms and anticipated conversion.
• Document approvals, execute agreements properly, and register security on the PPSR if applicable.
• Model dilution outcomes at different caps/discounts so there are no surprises when your note converts at the next round.

If you’d like a consultation on using a convertible note for your Australian business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.