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Q

What does the interest rate indicate on a convertible note?

A

The interest rate of a convertible note indicates how much interest accrues to the investor prior to the note’s conversion to equity or its repayment as cash when called.

On the west coast in the US, typical interest rates on most convertible notes are a nominal 2% (and cannot legally be lower or they might not be viewed as a convertible debt instrument). Elsewhere in the US, typical interest rates on most convertible notes range from 4-8%.

For example, with an interest rate of 8%, $100 invested on day 0 would convert as if $108 had been invested on day 365, if conversion happens on day 365.

From an investor standpoint, the interest rate term is not as impactful to startup returns as picking the right startups to fund, and as other convertible note terms such as the conversion cap and/or discount rate. This is one reason why the interest rate has come down to a nominal 2% for most west coast convertible notes, and why the SAFE (see SAFE)was introduced as a simpler investment vehicle alternative to the convertible note.

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