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A convertible note is an investment vehicle often used by seed investors investing in startups who wish to delay establishing a valuation for that startup until a later round of funding or milestone. Convertible notes are structured as loans with the intention of converting to equity.
- How does a convertible note work?
- Why are convertible notes bad?
- Why do companies issue convertible notes?
- What is the main advantage of a convertible note?
How does a convertible note work?
A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round; in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.
Why are convertible notes bad?
When Convertible Notes Are Bad
Convertible notes are destructive when used carelessly. Having too many notes or poorly structured notes outstanding can put your company and later negotiations at risk by complicating your cap table.
Why do companies issue convertible notes?
Companies issue convertible bonds to lower the coupon rate on debt and to delay dilution. A bond's conversion ratio determines how many shares an investor will get for it. Companies can force conversion of the bonds if the stock price is higher than if the bond were to be redeemed.
What is the main advantage of a convertible note?
The main benefit of a convertible note is their relatively simple structure. Startup financing rounds can quickly become complex and take up significant time and money. Convertible note financings tend to be faster, simpler, and cheaper than priced rounds.
