Convertible Note 

A convertible note is a document that at first verifies the receipt of funds as debt that the holder may choose to repay, or that, under certain conditions and upon the occurrence of certain events, may be convertible into the specified number of equity shares of the startup company.They start as debt but have the potential to convert into equity under predefined conditions.

Convertible notes often play a role in the startup financing lifecycle, serving as a bridge between initial seed funding and more mature funding rounds.

Convertible notes were first introduced as a quick and easy way for businesses to get money without having to figure out their worth right away. They offer a means of bridging the gap between an equity financing round that is more substantial and seed investment.Conversion often occurs during a subsequent equity financing round, such as a Series A funding round.Other trigger events may include reaching a specific milestone or achieving a predetermined valuation.

Working Mechanism:

• Investors provide the business money in return for convertible notes.
• The notes provide the opportunity to convert into equity when certain requirements are completed, rather than repaying the principle amount plus interest. 
• The notes also accumulate interest.
• A conversion discount could be included in convertible notes as a way to thank early investors. As a result, they can convert their notes into equity at a cheaper price per share than the equity round's later investors.

• The highest valuation at which the notes can be converted into equity is determined by a valuation cap. By guaranteeing that they get a reasonable portion of ownership even in the event that the company's valuation rises in the next round, it safeguards investors.

• Dilution protection, which protects initial investors against the effects of subsequent stock issuances that can lower their ownership percentage, may be provided by convertible notes.

• Convertible notes have a maturity date. After maturity it must be repaid or converted.
• If conversion hasn't happened by then, the company can be forced to repay the principle and any interest that has accrued, if there is no extension of agreements.

• Convertible notes offer economic advantages by deferring the valuation discussion, allowing startups to secure funding more quickly and investors to participate in potential future growth.

How convertible note is different from bill of exchange and hundi?

● Hundi is a traditional Indian financial tool that is frequently employed in rural regions for interest-free short-term loans.

● A bill of exchange is a formal request, frequently used in business transactions, from one party to another for the payment of a particular amount of money on a given date.

● Convertible Note is debt instrument that can be converted into equity shares of a company at a later date, typically used in startup financing.

Instruments similar to Convertible notes.

A similar financial instrument to a convertible note is a SAFE (Simple Agreement for Future Equity), which is also commonly used in startup financing.

SAFEs are intended to make the early-stage startup funding process easier and faster. Unlike convertible notes, SAFEs do not carry an interest rate or maturity date. 

Options, Warrants, Participating Preferred Stock, Convertible Preferred Stock are other instruments similar to Convertible notes.