What Is a Convertible Note in Australia?

Raising early funding can feel tricky. You want to move fast, keep costs low and avoid locking in a valuation too early - but you still need a clean, legally sound path for investors to back your growth.

This is where convertible notes often come in. They’re popular with Australian startups because they can be quicker than a full equity round and flexible enough to suit both founders and early investors.

In this guide, we break down what a convertible note is, how it works in Australia, the pros and cons for small businesses, and the key legal steps to get right before you issue one.

What Is A Convertible Note?

A convertible note is a short-term loan from an investor that’s designed to convert into shares in your company later.

Instead of agreeing a valuation today, the investor lends your business money now and gets equity at a later “conversion event” - usually your next priced equity round. The investor typically receives a discount and/or a valuation cap to reward their early risk.

Think of it as a bridge between where you are today and the next equity raise. It’s still a legally binding finance instrument, but it’s simpler and faster than negotiating a full share price and issuing ordinary shares right away.

Key points to remember:

• It starts as debt (often with interest) and becomes equity later under agreed conditions.
• It delays valuation negotiations until the next equity round or another trigger.
• It’s documented in a dedicated Convertible Note agreement with specific terms around conversion, maturity and investor protections.

How Do Convertible Notes Work In Australia?

While every deal is different, most notes follow a similar flow. Here’s the typical lifecycle in plain English.

1) Issue: Investor Lends Money To The Company

Your company and the investor sign a convertible note deed or agreement. The investor transfers funds to the company. The note records the principal amount, interest rate (if any) and all the conversion mechanics.

2) During The Term: Interest Accrues And Conditions Apply

Most notes accrue interest (simple or compounding). Some are zero-interest, especially in early-stage deals. The note may also include investor information rights and restrictions on things like issuing senior debt.

3) Conversion Event: Debt Converts To Shares

On a qualifying equity round (or another defined trigger), the note converts to shares at a discounted price or at a price implied by a valuation cap - whichever is more favourable to the investor (depending on the negotiated terms).

• Discount: A percentage reduction to the new round price (e.g. 20% discount).
• Valuation Cap: A maximum valuation used to calculate the conversion price if the round price implies a higher valuation.
• Most-Favoured Terms: Some notes include protections to ensure the investor receives terms no worse than new investors in the round.

4) Maturity: What If There’s No Equity Round?

If no conversion event occurs by the maturity date, the note will typically either:

• Repay in cash (principal plus accrued interest), or
• Convert at a fallback price formula set out in the note (sometimes at the cap).

This is negotiated. Many early-stage companies prefer conversion over repayment to preserve cash, but it must be clearly drafted.

5) Other Triggers: Sale Or IPO

Notes often include additional conversion or repayment mechanics on a change of control (e.g. sale of the company) or an IPO. These can be nuanced; draft them carefully so the outcome is predictable and fair.

Do Convertible Notes Require Disclosure Documents?

Fundraising in Australia is regulated under the Corporations Act 2001 (Cth). Many early-stage raises rely on the small-scale personal offers exemption or investor eligibility categories to avoid a full prospectus.

Be sure your offer fits an available pathway, such as the small-scale offering rules under section 708, or that you’re dealing with eligible or sophisticated investors. Getting this wrong can invalidate your raise and expose the business to penalties.

Pros And Cons For Small Businesses

Convertible notes can be powerful - but they’re not a silver bullet. Weigh the benefits and trade-offs for your situation.

Advantages

• Speed to funding: They’re typically faster and cheaper to negotiate than a full equity round.
• Delay valuation: You avoid locking in an early valuation before meaningful traction, which can protect founder equity.
• Flexible terms: Discounts, caps, interest and maturity can be tuned to your priorities and risk profile.
• Simpler cap table now: You issue fewer classes of shares until the next round, which can keep things tidy in the short term.

Disadvantages

• Future dilution unknown: Because valuation is set later, founders don’t know exactly how much equity will be issued on conversion.
• Stacking notes: Multiple notes with different terms can become complicated at conversion.
• Debt on the books: Notes are debt until they convert - if maturity hits without a round, you may owe cash you can’t easily repay.
• Investor expectations: Some investors prefer equity now for governance rights; a note might require added investor protections to get them comfortable.

Legal And Compliance Checklist Before You Raise

Getting the legal fundamentals right protects your raise, your relationships with investors and your company’s future rounds. Here’s a practical checklist.

1) Confirm Your Company Setup

Convertible notes are issued by companies, so make sure your structure is in order - including your constitution and share capital. If you don’t already have one tailored to startups, consider adopting a clear, investor-ready Company Constitution before you start raising.

2) Map Your Fundraising Pathway

Identify which fundraising exemption applies (e.g. small-scale personal offers or eligible investor routes) and design your process around it. Document the basis on which each investor qualifies. Keep careful records in case of future due diligence.

3) Prepare Your Core Deal Documents

• Convertible Note agreement: Sets out the amount, interest, cap, discount, conversion triggers and investor protections.
• Ancillary equity documents: If conversion is expected soon, be ready with the template Share Subscription Agreement and any required board/shareholder approvals for a clean equity round.
• Governance documents: If you have co-founders, align on a Shareholders Agreement so you’re not negotiating internal rules mid-raise.

4) Consider Security And Priorities

Most early-stage notes are unsecured. If an investor requests security over assets, think through the impacts on later lenders and investors. Where security is agreed, register the interest on the PPSR promptly to protect priority - this is often handled alongside a register a security interest engagement.

5) Align Your Cap Table And Option Pool

Decide how you’ll handle the option pool (before or after conversion) and be explicit in the note. Ambiguity here can create friction at your next round and surprise dilution for everyone.

6) Create A Clear Communication Pack

Even if you’re using exemptions, investors expect a concise deck and a short information memo outlining the key risks. Keep your note terms simple and consistent across investors to avoid a messy conversion later.

7) Board And Shareholder Approvals

Follow your constitution for approving note issuance. Minute resolutions properly and maintain a clean data room. This discipline pays off when institutional investors run due diligence.

What Terms Should Your Convertible Note Include?

Here are the common terms you’ll see - and what to consider when negotiating them.

Principal And Drawdown

Is the full amount advanced on signing, or in tranches subject to milestones? Tranche structures can reduce risk for investors but add compliance steps for you between drawdowns.

Interest

Interest rates vary widely (including 0%). If interest accrues, confirm whether it’s simple or compounding and whether it also converts into equity or is payable in cash at maturity.

Discount And Valuation Cap

These drive pricing at conversion. A typical approach is to apply the greater of the discount or the cap-based price, favouring the investor. Model a few scenarios so you know the likely post-raise dilution at different outcomes.

Maturity Date And Fallback

Choose a realistic maturity window (often 12-24 months). Be explicit about what happens at maturity if no qualifying round occurs - cash repayment, forced conversion, or a negotiated extension. Avoid relying on “we’ll work it out later.”

Qualified Financing Threshold

Define what counts as a “qualifying” equity round (e.g. minimum amount raised). If the threshold is too high, you risk missing conversion opportunities. If it’s too low, you might trigger conversion prematurely.

Conversion Mechanics

• Share class: Notes usually convert into the same class issued in the qualifying round (often preference shares). State this clearly.
• Option pool treatment: Clarify whether the pool is calculated pre- or post-money for conversion pricing.
• Round-specific adjustments: Address anti-dilution and liquidation preference if relevant to the share class.

Investor Protections

Early investors may ask for information rights, consent rights for certain major actions, or most-favoured nation (MFN) clauses. Keep protections reasonable so you don’t constrain day-to-day operations.

Transfer Restrictions

Limit transfers to maintain a clean cap table. Allow transfers to affiliates or with company consent to provide flexibility without opening the door to unwanted holders.

Change Of Control And IPO

Spell out what happens if you sell the company or list before conversion. Common outcomes include automatic conversion at the cap or a premium repayment multiple. Align this with your commercial strategy and investor expectations.

Regulatory And Eligibility Warranties

Include confirmations that the offer is compliant with the Corporations Act fundraising rules and that each investor is eligible under your chosen pathway (for example, aligning with section 708 personal offers).

Alternatives To Convertible Notes

Convertible notes are just one tool. Consider these alternatives and how they compare.

SAFE Notes

A SAFE (Simple Agreement for Future Equity) is not debt - there’s no interest or maturity. It converts into equity on a future round using a discount and/or cap. SAFEs can be simpler, but you still need to navigate fundraising exemptions and conversion mechanics. If you’re leaning this way, review a SAFE note option alongside your note terms to decide which best suits your risk and timeline.

Priced Equity Round

Issuing shares now (often via a Share Subscription Agreement) sets valuation immediately and gives investors voting and dividend rights straight away. It can be cleaner for governance, but tends to take longer to negotiate and document.

Friends And Family Or Small-Scale Rounds

Smaller cash needs might be solved with a modest equity issue or a short bridge, still within the small-scale personal offers regime. Keep everything documented and consistent with your Shareholders Agreement so your next round isn’t derailed by loose ends.

Other Capital Sources

Depending on your sector and traction, grants, revenue-based finance or strategic partnerships may be viable alternatives. Whatever path you choose, ensure your fundraising stays within the Corporations Act exemptions that apply to you and, where relevant, your investor base (including any sophisticated investors).

Key Takeaways

• A convertible note is a loan that converts into shares later, letting you raise now and set valuation at your next equity round.
• Core economics are driven by the discount, valuation cap, interest and maturity - model scenarios to understand likely dilution.
• Before issuing notes, confirm your fundraising pathway (e.g. small-scale personal offers under section 708) and document investor eligibility.
• Put clean foundations in place - a fit-for-purpose Company Constitution, aligned founder terms via a Shareholders Agreement and investor-ready processes will save time later.
• Keep terms consistent across investors and be explicit about maturity, conversion triggers and option pool treatment to avoid disputes.
• Consider alternatives such as a SAFE note or a priced equity round if they better suit your timeline, governance needs and investor expectations.
• Well-drafted documents - from the Convertible Note to the Share Subscription Agreement - help you raise with confidence and keep your next round clean.

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