Startups often need to raise funds before they’re ready to set a valuation. Whether you’re still building your MVP or figuring out go-to-market, traditional equity rounds may feel premature. This is where convertible note can bee useful. It is a powerful instrument that lets you raise capital quickly while deferring valuation discussions.
What Is a Convertible Note?
A convertible note is a short-term debt that converts into equity during a future financing round.
Think of it as a loan that turns into ownership later.
Startups receive money today. Investors get equity later, usually at a discounted rate or with a valuation cap when a larger round is raised.
How It Works (With an Example)
Let’s say you raise ₹1 crore through a convertible note.
- You agree it will convert at your next priced round
- The investor gets a 20% discount or a ₹10 crore valuation cap
If your Series A is at a ₹20 crore post-money valuation, the investor chooses the more favourable term, likely the valuation cap, and converts their ₹1 crore into equity at a ₹10 crore valuation. That gives them more shares than a direct investment at ₹20 crore.
Key Terms in a Convertible Note
| Term | Meaning |
|---|---|
| Principal | Amount invested |
| Interest Rate | Annual interest that accrues until conversion (often 4–8%) |
| Discount Rate | % discount on the share price at the next round (e.g., 20%) |
| Valuation Cap | Maximum valuation at which the note will convert |
| Maturity Date | Deadline for conversion or repayment |
| Conversion Trigger | Usually the next qualified equity round |
Why Founders Use Convertible Notes
- Skip valuation debates at early stages
- Speed up fundraising with simpler documents
- Delay dilution until your valuation is easier to defend
- Align incentives
Why Convertible Notes Matter in India
1. Bridging the Valuation Gap
Startups in India often don’t have the traction or metrics to negotiate traditional rounds. Convertible notes offer a way to:
- Close deals faster
- Avoid undervaluation
- Onboard early believers without over-diluting
2. Legal & Regulatory Nuances
Convertible notes are legally allowed only for DPIIT-recognized startups, and each investor must invest at least ₹25 lakh in one tranche.
Most early-stage Indian startups use CCPS (Compulsorily Convertible Preference Shares) to mirror convertible note flexibility. CCPS is an equity structure but allows for:
- Deferred valuation
- Customizable conversion triggers
- Legal compliance under Indian company law
3. Speed and Simplicity
Convertible notes let you:
- Close rounds in weeks, not months
- Spend less on legal and negotiation overhead
- Focus on product, not paperwork
4. Adoption and Caution
Convertible notes (and CCPS) are now used in:
- Pre-seed and seed rounds
- Bridge financing between rounds
- Angel and accelerator rounds (e.g., Y Combinator)
But be cautious:
- Convertible notes are still debt until they convert
- Multiple overlapping notes can complicate your cap table
- Unrealistic valuation caps can lead to unexpected dilution
Checklist for Indian Founders
| Consideration | Recommendation |
| DPIIT Eligibility | Required for issuing convertible notes |
| Minimum Investment | ₹25 lakh per investor, one tranche |
| Foreign Investment | Ensure RBI + FEMA compliance |
| Tax Implications | Watch for Section 56(2)(viib) risks |
| If Not Eligible | Use CCPS with structured SHA |
| Clarity of Terms | Set cap, discount, maturity, and triggers in writing |
Convertible Note vs SAFE vs CCPS (India Context)
| Feature | Convertible Note | SAFE | CCPS (India) |
| Type | Debt | Contractual promise | Equity Instrument |
| Interest | Yes | No | No |
| Legally Allowed in India | Yes (limited) | Not recognized | Yes (widely used) |
| Maturity Date | Yes | No | N/A |
| Use Case | Quick raises, bridges | Fast pre-seed | Early equity with flexible terms |
Final Thought
Convertible notes let you raise capital without slowing down. Just be sure the terms you sign today don’t surprise you tomorrow.
Used wisely or through structured CCPS where notes aren’t feasible, this tool lets Indian founders keep momentum, defer dilution, and focus on what matters: building.