Which of the following best describes convertible debt?

Convertible debt is characterized as a loan that can be converted into equity at a later date. This financial instrument allows investors to lend money to a company with the option of turning that debt into shares of the company’s stock, often during a future financing round or upon the occurrence of a specific event.

This feature is advantageous to both the lender and the company; it gives investors the potential for equity participation if the company grows and succeeds, while the company can attract investment by initially offering debt with a lower immediate cost. The conversion terms, including the conversion ratio and timing, are typically defined at the outset of the agreement.

The nature of convertible debt distinguishes it from traditional bank loans, which do not offer equity conversion; grants, which do not require repayment; and common stock, which represents ownership in a company but does not originate from a loan structure. Understanding convertible debt is essential for evaluating startup funding options and recognizing how financial instruments can be structured to support growth and investment strategies.