This seems like an elegant solution to the problem. So these convertible notes pay interest, right? is this generally fairly high interest? I mean, if I were to ask a bank for a loan without a personal co-sign,[1] they would charge me a pretty hefty rate if they looked at me at all.
At least for my company, even upon success the chance of an investment round is... small, so I imagine the people buying those convertible notes would still want some upside.
[1] I'm assuming these convertible notes are corporate debt, not personal debt backed by the founders
I see the benefit of the convertible note from the investing founder's standpoint, and I appreciate the violence of your disagreement, but you've misaligned the founders' incentives - the investing founder would be more likely to throw in the towel and get her money back.
Obviously the equation changes if the founder is investing $1M, but in the $10k-$50k range (which I'm guessing is a lot closer to the actual number than your $250k example) I'm not as convinced that the investing founder should get preferred or convertible notes.
You're going to need either a much firmer definition of startup or a much more defined range to make this have even the slightest bit of credibility.
Example: Alice puts in $250k. Alice and Bob split the company 60/40, common shares. After a year, there's $100k left in the bank, and Alice and Bob decide to call it quits. At this point, Bob leaves with $40k. If Alice had preferred shares, she would get more of her money back.
But even preferred shares are a terrible idea. The right thing is to give the founder a convertible note. That means the founder has debt if the company folds early (and gets his/her money back), and if the company raises a financing round, they just convert on those terms in to the same preferred shares as the subsequent investors.