Last updated: 31 October 2026
A convertible note is a loan to a startup that is expected to convert into shares at the next equity financing round, rather than be repaid in cash.
What is a convertible note?
According to Goodwin, a convertible loan note is “a debt instrument – it is a loan that is never meant to be paid back but instead convert into shares in the capital of the company.” In practice, the note is issued now and converts when the company raises its next equity financing round. The note is still debt until conversion.
How does the discount work?
A discount gives the note holder a lower price per share than investors in the next round. Discounts typically range between 10% and 20% in normal conditions, and 25–35% in stressed markets. For example, if the next round prices shares at £1.00 each and the note has a 20% discount, the note converts at £0.80 per share. The lower price means the same money buys more shares than it would for a new investor in that round.
What is a valuation cap?
A valuation cap “provides for a maximum conversion price at which loan notes convert on the next equity financing round”, protecting investors if the company grows a lot. Without a cap, a very high round valuation could make the note holder’s shares expensive, even after a discount. The cap sets a ceiling on the price used for conversion. For example, with a cap of £4m and a round pre-money valuation of £8m, the cap price is half the round price: £0.50 against £1.00. This is a simplified example and ignores the option pool and fully diluted share count.
How does interest work?
Interest on a convertible note may be absent or limited, although interest is becoming more common in uncertain markets. For example, £100,000 at 8% simple interest for 18 months accrues £12,000, so £112,000 converts. At £0.80 per share, that buys 140,000 shares. At the cap price of £0.50 per share, it buys 224,000 shares. The investor usually gets the better of the cap or the discount, meaning the price that gives more shares. The worked figures above are our calculations based on the stated assumptions.
What happens at maturity?
Maturity, also called the long-stop, is typically 12–18 months from issue, and sometimes 24 months or more. If the company has not raised a qualifying equity round by then, the note may not have converted. At maturity, investors usually have the option to seek repayment if conversion has not happened. The exact terms, including any extension rights, should be read in the note document.
Note vs SAFE and UK tax relief
A SAFE “is not a debt and not a loan – it has no interest and no maturity date.” A convertible note, by contrast, is debt and may carry interest and a maturity date. That difference matters for founders and investors when choosing between the two instruments. For investors seeking SEIS or EIS relief, a convertible loan note “will not be appropriate”. Tax treatment depends on the specific facts and current HMRC rules, so readers should check HMRC guidance or take advice from a qualified tax adviser.
| Item | Figure |
|---|---|
| Discount, normal conditions | 10–20% |
| Discount, stressed markets | 25–35% |
| Example round price | £1.00 |
| Discounted conversion price at 20% discount | £0.80 |
| Valuation cap | £4m |
| Round pre-money valuation | £8m |
| Cap price vs round price | £0.50 vs £1.00 |
| Principal | £100,000 |
| Interest rate | 8% |
| Term | 18 months |
| Accrued interest | £12,000 |
| Total amount converting | £112,000 |
| Shares at £0.80 | 140,000 |
| Shares at £0.50 | 224,000 |
| Maturity, typical | 12–18 months |
| Maturity, sometimes | 24 months or more |
Frequently asked questions
Is a convertible note the same as equity?
No. A convertible note is a debt instrument until it converts. It becomes equity only when it converts into shares at a later equity financing round.
Does a convertible note always pay interest?
No. Interest may be absent or limited, although it is becoming more common in uncertain markets. In our worked example, 8% interest accrues and is added to the amount that converts.
What does a valuation cap protect against?
It protects the investor if the company grows a lot before the next round. The cap sets a maximum conversion price, so the note holder does not pay the full round price.
What happens if the note reaches maturity without converting?
Investors usually have the option to seek repayment if conversion has not happened. The exact terms are set out in the note document.
Can a UK investor use a convertible note for SEIS or EIS relief?
A convertible loan note “will not be appropriate” for investors seeking SEIS or EIS relief. Readers should check HMRC guidance or take advice before relying on any tax treatment.
Sources
Figures and prices were checked on 31 October 2026; check the linked sources before relying on them. This article is general information, not tax, legal or investment advice.
