How do Convertible Notes Work?
A convertible note is short-term debt that converts into equity. The basic mechanics of a convertible note include an investor loaning money to a startup, and instead of a return in the form of principal plus interest, the investor would receive equity in the company.
Convertible notes are often used by startups to structure the first round of funding from outside investors. They often help the founders raise money by incentivizing future stock in the company.
Convertible notes can also help investors from a tax standpoint. Investors do not appreciate running into large taxable gains based on the appreciated share prices, and with convertibles note being a loan, the valuation of the startup is not required and, if there is no valuation, there are no problems of share pricing and taxes.