Using Convertible Notes to Raise Capital Without Losing Control
What Exactly Is a Convertible Note?
A convertible note is a short-term loan from an investor that can turn into equity later, usually when a company hits certain milestones or raises another round of funding.
Think of it as a bridge between debt and ownership.
It gives investors potential upside (future equity) while giving business owners breathing room before deciding how much equity to give up, or whether to give any at all.
How Convertible Notes Work
Here’s the simple version:
An investor loans your company money.
The note includes interest (often 5–8%) and a maturity date (12–24 months).
Instead of being repaid in cash, the note may convert into stock or membership units later — typically during your next financing round.
If no trigger event occurs, you pay the note back like normal debt.
This flexibility is exactly why convertible notes are so popular for early-stage businesses and real estate ventures that need capital but aren’t ready to value the company.
Why Founders and Developers Use Them
Convertible notes work best when:
You need quick funding without lengthy valuation debates.
You want to delay giving away equity.
You want to protect control while offering investors upside potential.
They can also help you avoid complicated partnership or shareholder negotiations in the early stages.
Key Terms You Must Understand
Before signing any convertible note, you need to understand these core concepts:
Valuation Cap:
Sets the maximum company valuation used to convert the note. The lower the cap, the better for the investor.Discount Rate:
Gives investors a discount (often 10–25%) when their note converts.Conversion Trigger:
Defines what event converts debt to equity — typically a new funding round or sale.Maturity Date:
When repayment is due if the note doesn’t convert.Interest Rate:
The annual rate applied while the note is outstanding.
Getting these details right determines who benefits, you or your investor.
Protecting Control While Using Convertible Notes
If you don’t want to lose control, structure your note agreements carefully:
Delay Conversion: Tie conversion only to specific triggers (like a new round), not automatically after time passes.
Retain Voting Rights: When conversion happens, issue non-voting equity units or shares.
Set Clear Caps: Avoid low valuation caps that could unfairly dilute your ownership.
Limit Information Rights: Investors don’t need board seats or operational control to be protected.
These terms should be clearly written, and compliant with both federal and state securities laws.
Legal and Compliance Considerations
Even if you’re raising funds privately, convertible notes are securities under U.S. law. That means you need to comply with Regulation D exemptions or your state’s equivalent filing requirements.
A transactional business attorney can:
Draft compliant convertible note agreements
Prepare investor disclosure statements
File Form D or state securities notices
Ensure the offering doesn’t trigger registration or investor qualification issues
Skipping these steps exposes your business to serious liability, including fines, rescission rights, and investor lawsuits.
Real-World Example
A developer needs $300,000 to acquire and entitle land. Rather than give up ownership in the project entity, they issue convertible notes to two private investors with a 12-month maturity, 8% interest, and a 1.5x repayment option.
If the project secures construction financing later, the noteholders can convert into non-voting profit-sharing units, or receive repayment with interest.
Result: The developer raises capital fast, stays in control, and investors still get upside.
Final Thoughts
Convertible notes are a smart middle ground, they attract investors without forcing you to give up equity too early. But they must be structured properly to protect your control and stay compliant with securities laws.
At Accord & Shield Legal, we help business owners, developers, and investors design investor agreements, including convertible notes, profit participation deals, and private offerings, that align with growth goals and minimize legal risk.
