Startup Law-1 Convertible Note
What Is a Convertible Note?
A Convertible Note, a funding method increasingly used in the startup ecosystem, is essentially a form of short-term, low-interest debt financing provided to early-stage startups. This mechanism allows founders to obtain the capital they need during the initial phase, while investors gain certain privileges for the next financing round.
An investor participates in the future equity round only if the startup raises new investment, and at that stage, the investor both acquires certain advantages due to the financing previously provided and shares in the privileges granted to the new investors.
Why Convertible Notes?
For very early-stage startups — even those that have not yet been formally incorporated and exist merely as an idea — determining a valuation and forecasting future performance may be extremely difficult for investors. This is precisely where the Convertible Note structure provides a significant advantage.
By using a Convertible Note, the parties can proceed with financing without conducting a valuation (pre-money valuation) at the initial stage. When the startup raises its next round, the investor receives equity in proportion to the principal amount plus interest, based on the valuation determined in that round.
This shortens investment processes and eliminates the lengthy due diligence stages typically required in equity investments conducted through capital increases.
Speaking of efficiency, another advantage of Convertible Notes is the simplicity of documentation. Unlike equity-based investments — which require shareholder agreements (SHA), amendments to the articles of association, general assembly approvals, trade registry procedures, and lengthy contracts — a Convertible Note can be completed with a concise agreement of approximately 5 to 10 pages.
Especially in companies with multiple shareholders, this provides significant practicality for both investors and founders by shortening the signing and closing processes.
What Privileges Do Investors Receive?
One of the most common privileges is the right to purchase shares at a discount during the future financing round. In essence, the investor is rewarded for identifying and supporting the early-stage startup and providing capital during its most vulnerable operational period.
The discount rate may vary depending on negotiations and the amount of financing provided. However, one of the critical considerations here is maintaining fairness. Excessive privileges granted at the Convertible Note stage may discourage future investors or be perceived as inequitable, potentially hindering the next round.
What Happens If No New Investment Is Raised?
If the startup does not raise a new investment by the maturity date, the founder is obligated to repay the principal amount, together with accrued interest, to the investor. In practice, the founder simply repays the debt obtained under the agreement and thus fulfills the financing obligation.
The Applicability of Convertible Notes Under Turkish Law
Like many modern investment mechanisms, Convertible Notes are designed for common law jurisdictions. The Turkish Commercial Code does not regulate a concept such as “conversion of shares,” and under the current statutory structure, such conversion is not technically feasible.
However, within the current Turkish startup ecosystem, different contractual and structural mechanisms are employed to functionally replicate the Convertible Note model, making its practical application possible.
For more information, please contact:
Gamze Müge Kan | gamze.kan@kyolegal.com
