How to record a convertible note: debt first, interest always, equity last

The short version

• A convertible note is recorded as a liability at issuance, not equity. Debit cash, credit convertible note payable. It stays on the balance sheet until it converts or is repaid.
• If the note bears interest, that interest accrues whether or not anyone books it. Most notes convert principal and accrued interest together, so interest you never recorded is dilution you never modelled.
• Classification follows the maturity date. Within twelve months it is a current liability, beyond that non-current. A note that quietly passes maturity becomes current, and in strict terms becomes a loan you have failed to repay.
• ASU 2020-06 removed the beneficial conversion feature model for most convertible instruments, effective for private companies in fiscal years beginning after 15 December 2023. Plenty of guides still tell founders to bifurcate. Confirm which regime applies before splitting anything.

Two years later, the note is bigger than the raise

A founder raises $500,000 on a note in early 2024. Five percent simple interest, three year maturity, a valuation cap, the usual shape. The money lands, the runway extends, the note goes into a folder.

Two years later a priced round comes together. Somewhere in the middle of the paperwork, the investor's counsel circulates the conversion mechanics, and the amount converting is $550,000.

Which is correct. It was always going to be $550,000. But the model said $500,000, the cap table assumed $500,000, and the books had a single liability line that had not moved since the day the wire cleared.

On the balance sheet it is a loan, whatever the deck called it

The resistance to this is understandable. Nobody experiences a note as borrowing. You pitched, an investor decided, money arrived, and the whole thing gets narrated internally as a raise. The word founders use is almost always "raised."

Accounting follows the legal form, and the legal form is a loan. There is a principal amount, a stated interest rate, a maturity date, and an obligation to repay if conversion never happens. That is debt, and it sits with the other debt.

At issuance the entry is two lines. Receive $500,000:

• Debit: Cash $500,000
• Credit: Convertible note payable $500,000

Then classify it. If maturity is more than twelve months out, it is a non-current liability. If maturity falls inside twelve months, it moves to current, and it moves on its own, without anyone doing anything, as the date approaches. This is the first of several things about a note that happens to you rather than being done by you.

The meter is running whether or not you record it

Interest on a convertible note is almost never paid in cash. It is stated in the document, it accumulates, and it settles at conversion or repayment. Which means there is no bank transaction to prompt the entry, no invoice, no reminder. The only thing that causes interest to appear in your books is somebody deciding to put it there.

The entry itself is not difficult:

• Debit: Interest expense
• Credit: Accrued interest payable

Run it on a schedule, monthly with the rest of your close or quarterly at minimum. Check whether the note specifies simple or compounding interest, because most early stage notes are simple and the difference is real over three years.

Here is why this matters beyond tidiness. Your interest expense is understated, which affects your reported loss and any tax position that depends on it. Your liabilities are understated, which affects any covenant, any lender, any diligence request. And the accrued balance is part of what converts, so the share count coming out of the round is calculated on a number your own records never showed. The bookkeeping error and the cap table error are the same error, discovered at the worst possible moment.

Interest on a convertible note is not a cost you pay. It is dilution on a timer.

Conversion is where the quiet years come due

When the priced round closes, the note and its accrued interest leave the liability section and reappear in equity. Nothing is being earned or spent. The entry is a reclassification:

• Debit: Convertible note payable
• Debit: Accrued interest payable
• Credit: Preferred stock or common stock, at par value
• Credit: Additional paid-in capital, for the remainder

The valuation cap and the discount do not show up in this entry. They do their work upstream, by setting the conversion price, which determines how many shares get issued. The accounting records the outcome, not the negotiation.

Two things worth confirming in the document rather than assuming. First, whether accrued interest converts alongside principal or is payable in cash, because some notes give the investor the choice. Second, whether conversion is automatic on a qualified financing or requires an election, since the threshold for "qualified" is a defined term and rounds have come in below it.

Some notes need more than four entries

Everything above describes a plain vanilla note converting on its stated terms. Notes are not always plain.

If the note has features that change value independently, a conversion price that floats with a formula, a redemption right, a payout multiple on a change of control, you may be holding an embedded derivative that requires separate measurement. If the note was issued with warrants, the proceeds have to be allocated between the two. If it was issued at a discount to face, or with meaningful issuance costs, there is a discount to amortise over the term.

There is also a live risk of following advice that has expired. Beneficial conversion features and the cash conversion model dominated convertible note guidance for years, and ASU 2020-06 removed both for most instruments, with private companies picking it up for fiscal years beginning after 15 December 2023. A blog post from 2019 will confidently tell you to do arithmetic that current guidance no longer asks for.

The honest caveat: this section is where a founder should stop and involve someone who does this for a living. Not because the entries are hard, but because deciding which entries apply requires reading the actual document, and that judgement does not survive being summarised.

What to actually track

Record the note the day the money lands, with its terms in the entry. Principal, rate, maturity date, cap, discount, and whether interest is simple or compounding, written into the memo field or an attached note. The document will be findable later. Whether anyone thinks to look for it is the open question.

Accrue interest on a schedule, not on an occasion. Tie it to your monthly close so it happens without being remembered. Interest that gets accrued when someone thinks of it gets accrued in the week before a term sheet.

Put maturity dates in the same calendar as your tax deadlines. A note reaching maturity is a decision point, extend, repay, or convert, and it arrives whether or not you have prepared for it.

Keep one register that your books and your cap table both read from. Principal plus accrued interest, per note, updated at close. If your financial model and your ledger disagree about how much debt is going to become equity, the disagreement should surface at month end rather than in diligence.

How this looks in practice

We spend a lot of time on the layer underneath a note: the monthly close where the interest actually gets accrued, the liability schedule that has to agree with the documents, the classification that moves on its own as a maturity date approaches. It is about as unglamorous as accounting gets, and it is the part that decides whether the number in your model matches the number your investor's lawyer produces.

For founders on Inkle, notes sit inside the same monthly close as everything else, so the accrual is a line in a process rather than something anybody has to remember. The outcome is not dramatic. It is that the balance sheet already says the right number on the day somebody finally asks.

The takeaway

The journal entries for a convertible note are simple, and they are not the difficult part. The difficult part is that a note asks nothing of you for years while quietly getting larger, and the only two moments it demands attention, maturity and conversion, are moments you do not choose. Record it as debt, accrue the interest on a schedule, and let conversion be arithmetic rather than a discovery.

A note is not money you raised. It is money you owe, until the day it becomes ownership you gave away.

FAQs

Is a convertible note debt or equity?

Debt, until it converts. A convertible note carries a principal amount, an interest rate, and a maturity date with an obligation to repay, so it is recorded as a liability on the balance sheet from the day the funds arrive. It becomes equity only when a conversion event occurs, typically a qualified priced round, at which point the balance moves out of liabilities and into stock and additional paid-in capital. Notes with unusual embedded features can require more involved treatment, but the starting classification is a liability.

Do I need to record interest if I never pay it in cash?

Yes. Interest on a convertible note is an expense in the period it accrues, regardless of whether cash moves, and the standard entry is a debit to interest expense with a credit to accrued interest payable. Skipping it understates both your loss and your liabilities. It also matters commercially, because most notes convert principal and accrued interest together, so the accrued balance forms part of the amount that dilutes existing shareholders.

What is the journal entry when a convertible note converts?

Debit convertible note payable and debit accrued interest payable to clear both balances, then credit the relevant stock account at par value and credit additional paid-in capital for the remainder. It is a reclassification within the balance sheet rather than income or expense. The valuation cap and any discount are not part of the entry itself, since their effect is to set the conversion price and therefore the number of shares issued.

Is a convertible note a current or non-current liability?

It depends on the maturity date, not the expected conversion date. If maturity falls more than twelve months from the balance sheet date, the note is non-current. If maturity falls within twelve months, it is current, and the reclassification should happen as the date approaches rather than after someone notices. Expecting a note to convert before it matures is not a basis for keeping it non-current.

Are SAFEs recorded the same way as convertible notes?

No. A SAFE is not a loan, so there is no interest and no maturity date, and the accounting is genuinely less settled than it is for notes. Depending on the terms and the framework applied, a SAFE may be presented as a liability, at fair value, or within equity, and practice varies between firms. If you have both instruments outstanding, do not assume one treatment covers both, and get the SAFE classification confirmed by whoever signs off on your financials.

What happens if a convertible note passes its maturity date without converting?

Strictly, the company then has a matured loan it has not repaid, which is a default position even when nobody intends to act on it. In practice investors usually agree to extend maturity or amend the terms, but that agreement needs to be documented rather than assumed. From a bookkeeping perspective the note stays a current liability with interest continuing to accrue under the original terms until it is repaid, converted, or formally amended.