The biggest lie in Silicon Valley is that raising your first money on a convertible note is easy.
Everyone tells you it is. Your lawyer, that advisor you just met, even Y Combinator. "Just use a SAFE," they say. "It's standard. It's simple. It saves you a ton of money on legal fees."
They're lying. Not maliciously, most of the time. They're just repeating what they've heard. They haven't been in the trenches, a founder staring at a term sheet with clauses that could kill their company before it even has a chance to live. I have. My first startup, MovieLaLa, we raised on notes. I’ve also invested in over 200 companies, many of which used notes. I’ve seen the good, the bad, and the company-destroying ugly.
I remember one deal, early in my angel investing career. A founder I really believed in was raising a seed round. He was smart, hungry, and had a great product. He also had a convertible note with a 20% discount and no valuation cap. He thought it was a great deal because he didn’t have to set a valuation. Two years later, a top-tier VC firm came in with a Series A offer at a $50 million valuation. The founder was ecstatic. Then the note converted. That early investor, who put in just $100,000, ended up with a massive chunk of the company, far more than his capital deserved. The founder’s equity was crushed. The VCs almost walked. The deal almost died. All because of a "simple" convertible note.
So, no, it's not simple. It’s a minefield. But it’s a minefield you can navigate. I’ve raised millions using convertible notes for my own companies, including RemoteTeam which was acquired by Gusto, and I’ve guided dozens of my portfolio companies through the process. This is my playbook. The real one.
The Only Thing That Really Matters: The Valuation Cap
Let's cut through the noise. When you're negotiating a convertible note, there are a bunch of terms. The discount, the interest rate, the maturity date. They all matter. But one term matters more than all the others combined: the valuation cap.
If you walk away from this article with only one thing, let it be this: never, ever, sign a convertible note without a valuation cap.
I mean it. I would rather walk away from a deal with a top investor than sign an uncapped note. It’s that important.
So what is it? The valuation cap is the ceiling on the valuation at which your investors’ money converts into equity. It’s the highest price they will pay for their shares. If you raise your next round of funding (your Series A) at a valuation higher than the cap, the note holders get to convert their investment at the cap price, not the new, higher price. It’s their reward for taking a risk on you early.
Without a cap, you are giving your earliest investors a blank check. You’re telling them, "Hey, thanks for the $50k. In a few years, when I’m raising at a $100 million valuation, you can have your equity at that price." It’s insane. You are punishing yourself for success.
I saw this happen to a company I advised. They were building a fantastic AI startup. They took $500k on an uncapped note from a group of angels. The founders were so focused on building the product, they just wanted the cash in the bank. They crushed it. Two years later, they had real traction, real revenue. A top Sand Hill Road firm wanted to lead their Series A at a $40 million post-money valuation. The founders were thrilled. Then the lawyers got involved. The uncapped notes converted at the new $40 million valuation. The angel investors, who took an early risk, got the exact same price as the VCs who came in two years later with much more data. The founders’ dilution was brutal. They ended up with a much smaller percentage of their own company than they should have. It almost killed their motivation.
Don't be those founders. Your first job as a founder in a negotiation is to protect your equity. A valuation cap is your shield. It aligns your interests with your investors. It says, "We all agree that the company is worth at most this much right now. If I do my job and blow it out of the water, you get a great deal, and I still own a meaningful part of my company."
So what’s a fair cap? It depends on your stage. For a true pre-seed, pre-product, just-an-idea-on-a-napkin company, you might see caps in the $3 million to $8 million range in Silicon Valley today. If you have a product, some early users, maybe a little revenue, you could be looking at $8 million to $15 million. It’s all a negotiation. But the number itself is less important than the fact that it exists. Start with a number, justify it, and don’t back down on having one.
The Discount: Your Second Most Important Term
Okay, so you’ve got a valuation cap. You’ve already won 80% of the battle. But there’s another term that can make a big difference: the discount.
The discount is a percentage off the Series A price that your note holders get as an additional reward for coming in early. It’s usually around 15-25%. The way it works is that when your Series A happens, the note converts at the lower of the valuation cap or the discounted Series A price.
Let's run the numbers. Say you have a note with a $10 million valuation cap and a 20% discount. You go out and raise a Series A at a $12 million valuation. The valuation cap is lower, so your note holders convert at the $10 million price. The discount doesn't even matter.
But what if you raise your Series A at an $8 million valuation? This happens. Not every company is a rocket ship from day one. In this case, the 20% discount kicks in. Your note holders would convert at a $6.4 million valuation ($8 million minus 20%), not the $8 million the new investors are paying. It’s their downside protection.
Most founders I talk to get this wrong. They think the discount is the main event. They’ll fight for a 15% discount instead of 20%, while completely ignoring the fact that they have an uncapped note. It’s like rearranging deck chairs on the Titanic. The cap is what saves the ship. The discount is just a nice bonus for the passengers.
I once invested in a company that gave me a 30% discount. It sounded great. But the cap was high, something like $25 million. The company ended up raising their next round at a $15 million valuation. My 30% discount was way better than the cap. I got a great deal. But the founder got hammered on dilution. He was so focused on the high cap, he didn't think about the scenario where he raised at a lower valuation. You have to think about all the scenarios. The good, the bad, and the ugly.
My advice? Offer a standard discount, 20% is fine. Don’t get bogged down in negotiating it. Focus your energy on the cap. A lower cap is almost always better for you than a lower discount.
Don't Forget the Interest Rate and Maturity Date
I know, I know. I said the cap is the only thing that matters. I lied. The interest rate and maturity date matter too, just not as much. Think of them as tie-breakers, or ways to show you’re a professional founder who understands how these things work.
The interest rate is exactly what it sounds like. It’s the interest that accrues on the investor’s money until it converts to equity. It’s usually a low number, somewhere between 2% and 8%. The accrued interest is added to the principal when the note converts. It’s not a huge deal for you, but it’s a nice little bonus for your investors. Don’t fight over it. Pick a number in the standard range and move on.
The maturity date is the date when the note is due. If you haven’t raised a Series A by the maturity date, the note holders have the option to either demand their money back (with interest) or convert their investment into equity at the valuation cap. This is a key protection for investors. It prevents you from taking their money and then never raising another round, leaving their investment in limbo. A typical maturity date is 18 to 24 months. This gives you enough time to make progress and raise a real round of funding.
I once had a founder try to negotiate a 5-year maturity date. He said he wanted to have plenty of time to build the business. I passed on the deal. A 5-year maturity date signals a lack of urgency. It tells me you’re not committed to building a high-growth company. It tells me you’re not confident you can hit your milestones. 18-24 months is the sweet spot. It’s long enough to give you room to breathe, but short enough to keep you focused.
My Playbook: A Summary
So, after all that, what’s the takeaway? It’s this: convertible notes are not simple. They are complex legal documents with real-world consequences. But they are also a powerful tool for founders who know how to use them. Here’s my playbook, boiled down to the essentials:
- Always have a valuation cap. This is non-negotiable. I don’t care if the investor is a celebrity. I don’t care if they’re offering you a million dollars. No cap, no deal.
- Negotiate the cap, not the discount. A lower cap is almost always better for you than a lower discount. Spend your negotiating capital where it matters most.
- Keep the other terms standard. 20% discount, 5% interest, 24-month maturity. Don’t reinvent the wheel. It just makes you look like an amateur.
- Use a standard document. YC’s SAFE is the industry standard for a reason. It’s well-understood by investors and lawyers. Don’t let your lawyer draft a custom 50-page convertible note. It’s a waste of time and money.
- Know your numbers. Before you talk to a single investor, know what valuation cap you want and be able to justify it. Have a clear plan for how you’re going to use the money and what milestones you’re going to hit.
Raising money is a part of the game. It’s not the fun part. The fun part is building a product that people love. But if you screw up your fundraise, you might not get the chance to do the fun part. So take it seriously. Learn the rules. And don’t let anyone tell you it’s simple.
Frequently Asked Questions
Is this guide based on real experience?
Every recommendation in this guide comes from direct experience, either from building and selling my own companies, or from patterns I've observed across 200+ angel investments. I don't write about things I haven't personally tested.
What if I disagree with some of the advice?
Good. That means you're thinking critically, which is exactly what a good founder should do. Take what resonates, test it, and discard what doesn't work for your specific situation. No advice is universal.
How often is this guide updated?
I revisit and update my guides regularly as I learn new things and as the market evolves. The core principles tend to stay stable, but specific tactics and tools get refreshed based on what's working right now.
Who is this guide designed for?
This guide is written for founders and operators who want practical, actionable advice rather than theoretical frameworks. Whether you're just starting out or scaling an existing business, the principles here apply across stages.