What Do I Need To Know About Convertible Notes? (2025 Updated)

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For many startups, there may be a time when you need to raise some capital to help grow your business. In 2025, the funding landscape is more dynamic than ever, with a wide range of financing options to suit your evolving needs.

There are many ways you can source this money – from bank loans and angel investment to venture capital and convertible notes. For additional insight into your legal obligations when raising capital, you might also explore our guide on registering a business in Australia.

In considering your options, you’ve probably come across the concept of “convertible notes”. So what are they?

In this article, I’ll break down what you need to know about convertible notes so you can decide whether they’re the right tool to help your startup grow in today’s market.

Why Should I Use A Convertible Note?

A convertible note is particularly useful when the valuation of your startup is uncertain. As a founder, you typically aim for a high valuation while investors might negotiate a lower figure. This instrument allows you to postpone detailed valuation negotiations until your next equity round.

Instead of getting bogged down by prolonged discussions, convertible notes enable you to secure funding quickly, deferring the more nuanced valuation debates to a later stage. This flexibility is invaluable in the competitive environment of 2025.

You can use the initial investment to accelerate your company’s growth, and by the time you raise your next equity round, your valuation is likely to be more accurate. For further insights into funding strategies and legal considerations, do have a look at our article on how to choose a small business lawyer.

Another advantage of convertible notes is that they are quick to execute. Their straightforward structure means you generally only need to negotiate a few key clauses, saving time and legal costs – a critical factor when every moment counts in today’s startup world.

What Is A Convertible Note?

At its core, a convertible note is a method of raising capital that blends elements of both debt and equity. Initially, it functions as a short-term loan which later converts into shares in your company at a future, pre-agreed valuation round.

For further insights into various financing mechanisms, have a read of our article on How Does Equity Financing Work?

In basic terms, equity financing means that investors receive shares in your company in exchange for the funds they invest.

Conversely, debt financing involves an obligation to repay the borrowed money – with the lender typically receiving interest payments. Convertible notes start as debt and then convert into equity, allowing you to delay setting a definitive valuation until your business has matured.

How Does A Convertible Note Work?

An investor who sees potential in your startup might decide to invest money in return for future equity, giving you the funds you need today without immediately diluting your ownership.

This means you receive cash investment now, but you don’t have to determine your company’s valuation or allocate shares right away.

Valuing a startup—especially in its early stages—is notoriously challenging. There are various methods to estimate your company’s worth, yet uncertainty remains a significant hurdle. Convertible notes allow you to delay the valuation process until more concrete data is available during your next funding round.

Your convertible note will set out a “trigger event” – typically your next equity raise – at which time the debt converts into equity. This arrangement lets you focus on growing your business while deferring complex valuation negotiations.

What Are The Key Terms That Are Negotiated?

Discounts

One of the key features of a convertible note is that it provides a discount for investors. This discount acts as a reward for the higher level of risk they take by investing early in your startup.

The discount effectively gives investors extra shares when the note converts to equity. The exact number of extra shares is based on a percentage agreed upon between you and your investors when the note is issued.

Valuation Cap

The valuation cap is the maximum price at which the initial investment will convert into equity. This means that if your startup’s valuation exceeds the cap in a future round, the conversion will occur at the capped rate, giving investors a larger equity stake.

If you don’t set a valuation cap and your next equity round achieves a very high valuation, the investor could end up with only a small percentage of your company. Most investors insist on a valuation cap to ensure a fair return that reflects the risks they’ve taken.

Especially if your startup grows exponentially between the time the convertible note is signed and your next equity round, a valuation cap protects investors by locking in conversion terms under more favourable conditions.

What To Take Away…

Thinking about your capital-raising options is essential for the long-term success of your new business in 2025. You have many choices at your disposal, and selecting the right one can have a significant impact on your company’s future.

Convertible notes remain an attractive option for many startups due to the flexibility they offer. They allow you to delay setting a firm valuation until your business has gained traction, which can be especially beneficial in today’s evolving market.

Are you considering using a convertible note to raise funds for your startup? Or are you exploring other financing avenues such as venture capital, angel investment, or even government grants? Our comprehensive guides on Business Structure and Getting Started With Your Legals offer valuable insights to help you make an informed decision.

It’s crucial to understand all the conversion terms and details of your agreement. With market dynamics evolving in 2025, many convertible note agreements also now feature enhanced clauses—such as pro-rata rights and early conversion incentives—to ensure both founders and investors benefit as your startup grows. For tailored legal support, consider our contract review service.

As the funding landscape evolves, so do the legal frameworks governing these transactions. It’s wise to regularly review your financing strategy and consult with a legal advisor to ensure your agreements comply with the latest regulations and best practices. For a broader overview, check out our article on regulatory compliance in business.

If you need advice on where to start or help navigating your convertible note agreement, feel free to contact us at team@sprintlaw.com.au or give us a call at 1800 730 617 – we’re here to help you secure the best funding solutions for your startup in 2025!

Esha Kumar

Esha is a law graduate at Sprintlaw from the University of Sydney. She has gained experience in public relations, boutique law firms and different roles at Sprintlaw to channel her passion for helping businesses get their legals sorted.

Tomoyuki Hachigo

Tomo is the co-founder of Sprintlaw and a commercial lawyer with a broad range of legal experience. Before starting Sprintlaw, he was an M&A lawyer at a top-tier law firm advising businesses of all sizes from large corporates to startups.

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