A convertible note is a debt instrument that can be converted into stock at the option of the holder or the issuer. More specifically, the investor can choose to convert the total amount of the note into equity when an institutional investor (such as a Venture Capitalist) makes an investment.
The cost of borrowing is lower for the seller, with convertible notes, since the buyer has the option of converting it into stock. Convertible notes are tools used by large companies to raise capital for their projects and operations. This is known as a debt offering since the company literally goes into debt to the investors until the price of the note is paid back, plus interest, or until it is converted into stock.
The company must record this debt on its balance sheet. If bankruptcy occurs, the note holders are considered creditors and must be paid back by the company’s remaining assets. Convertible notes are a way for companies to raise capital without having to use their assets or give up ownership in their company. This leaves their assets free to do other things to generate capital for the business.