What Do I Need To Know About Convertible Notes? (2026 Updated)

Raising money for your startup is exciting - and a little daunting.

If you’re not ready to lock in a valuation (or you’re trying to keep a funding round moving fast), you’ve probably heard investors mention “convertible notes”.

This (2026 updated) guide walks you through what a convertible note is, how it works in a New Zealand context, the key terms to watch for, and the legal documents you should have in place so you’re protected from day one.

What Is A Convertible Note (And Why Do Startups Use Them)?

A convertible note is a way to raise funds where an investor lends money to your company now, and instead of being repaid like a normal loan, the amount can convert into shares later (usually at your next funding round).

In plain English: it’s a loan today that can become equity tomorrow.

Convertible notes are popular for early-stage startups because they can:

• Delay valuation until you have more traction (and hopefully a higher valuation);
• Move faster than a full priced equity round (less negotiation around valuation and share pricing upfront);
• Reduce legal and admin overhead compared to issuing shares immediately (though you still need proper documentation); and
• Give investors a clear pathway to become shareholders at a later milestone.

That said, convertible notes aren’t “simple” just because they’re common. The terms you agree to now can have a huge impact on your cap table later - especially if your next round is delayed, your valuation changes, or you raise multiple notes.

Convertible Notes vs Equity (Shares)

With an equity raise, you’re issuing shares now at an agreed valuation, and the investor becomes a shareholder immediately.

With a convertible note, the investor is usually a creditor first (a lender), and only becomes a shareholder if/when the note converts.

This difference matters because creditors can have different rights and leverage compared to shareholders - particularly if the company runs out of cash or the note reaches maturity.

Convertible Notes vs SAFE Notes

You might also hear about a SAFE (Simple Agreement for Future Equity). While both instruments are used to delay valuation, a SAFE is generally not debt (no “loan” repayment obligation in the same way, and usually no interest or maturity date).

SAFE notes are increasingly used in startups, but they still need careful drafting to match New Zealand company law realities and your investment strategy. If you’re comparing options, a tailored SAFE note can be a good alternative depending on what you and your investors want.

How Does A Convertible Note Work In Practice?

Most convertible notes follow the same basic structure:

1. Investor advances funds to the company (the “principal amount”).
2. The note accrues interest (sometimes), and has a maturity date (often 12–24 months, but it varies).
3. A conversion event happens, commonly your next equity raise, and the outstanding amount converts into shares - typically at a discount or subject to a valuation cap.
4. If no conversion event happens before maturity, the note may become repayable, or there may be other outcomes (like investor choosing to convert at a pre-agreed price).

Because a convertible note is usually a form of debt until conversion, it’s important to treat it as a real legal and financial commitment - not just “placeholder paperwork”.

What Counts As A “Conversion Event”?

A conversion event is the trigger that turns the outstanding note amount into shares. Common conversion events include:

• A priced funding round (e.g. Series A) where new investors buy shares at a set price;
• A liquidity event (sale of the company, or a major asset sale);
• An IPO (less common for early-stage NZ startups); or
• Optional conversion at maturity (depending on how the note is drafted).

“Priced round” conversion is usually the core scenario, so the definition of what qualifies as a priced round (including minimum raise amount) is a key negotiation point.

Do You Still Need To Issue Shares Properly?

Yes. Even though the note is agreed today, the actual conversion into shares later still needs to comply with:

• your company’s constitution (if you have one);
• any shareholders agreement or investor rights documents;
• director approvals and company resolutions; and
• the Companies Act 1993 requirements around share issues.

It’s one reason startups often adopt a Company Constitution early - so the conversion mechanics can be smoother and the rules are clear.

What Key Terms Should I Watch For In A Convertible Note?

A convertible note can look short and friendly on paper, but the commercial terms inside it are where the real risk (and value) sits.

Here are the key terms you’ll usually see - and what they mean for you.

1. Valuation Cap

A valuation cap sets the maximum valuation at which the note converts, even if your next round values the company higher.

From an investor’s perspective, it rewards them for taking early risk. For you, it can be a fair trade-off - but you need to understand that a low cap can cause more dilution than you expect.

Example: If the cap is $5M but your Series A valuation is $10M, the note converts as if the company was worth $5M, meaning the noteholder gets more shares than a new Series A investor paying the $10M valuation.

2. Discount Rate

A discount gives the noteholder a reduced price per share compared to new investors in the next round (for example, a 15–25% discount).

Sometimes notes use a discount only, sometimes a cap only, and sometimes both (with the investor getting the better outcome).

3. Interest Rate

Many convertible notes accrue interest. Instead of being paid in cash, the interest often converts into shares as well.

This might sound minor, but over time it affects dilution - and if the note doesn’t convert, it increases how much you may have to repay.

4. Maturity Date

The maturity date is when the note is due. If you haven’t had a conversion event by then, the note might:

• be repayable (principal + interest);
• automatically convert (at a pre-agreed price or cap);
• extend by agreement; or
• trigger renegotiation (which can be stressful if you’re fundraising under pressure).

It’s worth thinking about the maturity date as a “deadline” that can affect your negotiating power later.

5. What Happens If The Company Is Sold?

A good convertible note clearly sets out what happens if there’s a sale of the company before the note converts.

Common options include:

• Repayment multiple (e.g. investor gets 1x–2x their investment back);
• Conversion on sale (investor converts immediately before the sale and shares in the sale proceeds); or
• Investor choice between repayment or conversion.

This is a big one. If the clause is too investor-friendly, it can make your business less attractive to buyers (because the noteholder takes too much value off the top).

6. Security (Secured vs Unsecured)

Some notes are unsecured (common in startups). Others are secured, meaning the investor has a security interest over company assets.

Secured notes can change the risk profile dramatically - and may have knock-on effects for future lenders and investors.

If you’re agreeing to security, you may also need to consider registration and priority issues, and ensure your broader funding strategy still works.

7. Information Rights And Control Terms

Investors sometimes request reporting obligations (financial updates), consent rights for certain actions, or “negative covenants” (things you can’t do without their approval).

These terms can be reasonable - but they can also become operational bottlenecks if they’re too strict, especially as you grow and need to move quickly.

What Legal And Compliance Issues Do NZ Founders Need To Think About?

Convertible notes sit at the intersection of company law, contract law, and (sometimes) financial services regulation.

You don’t need to become a lawyer to raise capital - but you do want to know where the risk points are, so you can get proper advice before you sign anything.

Companies Act 1993: Share Issues, Director Duties, And Solvency

In New Zealand, the Companies Act 1993 is a key framework for how companies issue shares and how directors must act.

Even if your note converts later, you should be thinking now about:

• whether the company has authority to issue the shares on conversion;
• what approvals are required (directors and/or shareholders); and
• how directors will meet their duties when taking on debt and issuing equity.

It’s also common for investors to expect a clear governance setup as you grow, including a Founders Agreement early on, and later a shareholders agreement once outside investors come in.

Fair Trading Act 1986: Don’t Oversell The Raise

When you’re fundraising, it can be tempting to paint the rosiest possible picture.

But you need to be careful about statements made to investors - including in pitch decks, emails, and financial forecasts. The Fair Trading Act 1986 generally prohibits misleading or deceptive conduct in trade.

That doesn’t mean you can’t be confident and ambitious. It means you should be honest about assumptions, risks, traction, and what’s still in progress.

Financial Markets Conduct Act 2013: Fundraising Can Trigger Disclosure Rules

Depending on who you raise from and how you structure the offer, fundraising may be regulated under the Financial Markets Conduct Act 2013 (FMCA).

Many early-stage raises rely on exemptions (for example, raising from wholesale investors). But it’s important to get this assessed properly, because non-compliant fundraising can create serious problems later - including when you do due diligence for a larger round.

If you’re preparing an investor pack, it can also be smart to use an Information Memorandum disclaimer so the information is framed carefully and consistently.

Think Ahead: What Will Future Investors Expect?

Future investors will scrutinise earlier notes. Common red flags include:

• unclear conversion terms (or terms that can’t practically be implemented);
• too many different noteholders with inconsistent rights;
• most-favoured-nation clauses that create cascading obligations;
• notes that mature soon (creating urgency and leverage for existing noteholders); and
• governance documents that don’t match what’s been promised.

This is where having a clean cap table and consistent investment documents can make a real difference to how smooth your next round feels.

What Documents Do I Need When Raising On A Convertible Note?

Convertible notes are “one document” in theory, but in practice, a proper setup usually involves a few moving parts.

The right documents will depend on:

• your company structure and current shareholders;
• whether the note is secured or unsecured;
• how many investors you’re raising from;
• whether you’re raising in tranches; and
• what your next funding round is likely to look like.

Convertible Note Agreement (The Core Document)

This is the primary contract between the company and the investor. It sets out the commercial terms we’ve covered above (cap, discount, maturity, interest, conversion events) and the legal mechanics.

Because your note terms can affect the control and economics of your business later, it’s not a document you want to DIY from an overseas template.

Cap Table Tracking And “Side Letter” Consistency

If you’re raising from multiple investors, you need to be very consistent with terms.

Founders often get into trouble when they agree to slightly different notes for different investors without realising how those terms interact when conversion happens.

If you’re using side letters (additional promises to specific investors), you’ll want to make sure they don’t contradict your main investment document, and they don’t accidentally create obligations you can’t meet later.

Company Governance Documents

If you’re bringing in investors (even if they’re not shareholders yet), you should check that your internal governance is solid.

Common documents include:

• a Company Constitution that allows for future share issues and sets clear rules;
• a Shareholders Agreement (particularly once you have external shareholders and want clarity on decision-making, exits, and rights); and
• director and shareholder resolutions and approvals.

Term Sheet (Optional, But Often Helpful)

Some founders start with a term sheet to agree the commercial points before paying for full legal drafting. This can keep negotiations efficient and reduce misunderstandings.

Just remember: term sheets can be binding or non-binding depending on wording and context, so don’t treat them as “informal” by default.

Privacy And Data Handling (If You’re Sharing Sensitive Info)

During fundraising, you may be sharing customer metrics, pipeline information, or product roadmaps. If you’re disclosing any personal information, you’ll need to think about your obligations under the Privacy Act 2020.

Even outside fundraising, most startups collecting customer information should have a properly drafted Privacy Policy so you’re clear about what you collect, why you collect it, and how you protect it.

Key Takeaways

• Convertible notes are a common way to raise early-stage capital because they let you delay valuation while giving investors a pathway to equity.
• Even though a convertible note can feel “simpler” than issuing shares now, the terms you agree to can have a major impact on dilution, control, and your next funding round.
• Key terms to focus on include the valuation cap, discount rate, interest, maturity date, conversion events, what happens on a sale, and whether the note is secured.
• In New Zealand, you should consider how the Companies Act 1993, the Fair Trading Act 1986, the Privacy Act 2020, and (often) the Financial Markets Conduct Act 2013 apply to your raise.
• Good documentation is essential - including a properly drafted convertible note agreement and governance documents like a Company Constitution and (as you scale) a Shareholders Agreement.
• If you’re unsure how a term will play out in future rounds, it’s worth getting tailored advice early, before you sign and before you’re negotiating under time pressure.

If you’d like help raising funds using convertible notes (or choosing between a note and a SAFE), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.