What is a Convertible Note?

What is a Convertible Note?

How does a convertible note works?

Convertible notes are originally structured as debt investments, but have a provision that allows the principal plus accrued interest to convert into an equity investment at a later date. This means they are essentially a hybrid of debt and equity.

What is a convertible note for dummies?

A convertible note is a way for seed investors to invest in a startup that isn’t ready for valuation. They start as short-term debt and are converted into equity in the issuing company. Investors loan money to the startup and are repaid with equity in the company rather than principal and interest.

What is the main advantage of a convertible note?

Convertible notes are a convenient method of raising capital, especially for startups because issuing them does not require company valuation. This works perfectly for startups as in the initial stages, a startup is just an idea. Hence, seed funding using convertible notes is quite a convenient option.

Do you have to pay back a convertible note?

Convertible notes are just like any other form of debt you’ll need to pay back the principal plus interest. In an ideal world, a startup would never pay back a convertible note in cash. However, if the maturity date hits prior to a Series A financing, investors can choose to demand their money back.

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.

Are convertible notes good for investors?

So at the end of the day, convertible notes (and other deferred pricing structures like SAFEs) are not good for investors and they are also not ideal for entrepreneurs. Their defects tend to get over-looked in very small rounds because they are a cheap and easy transaction to do.

Are convertible notes considered debt?

A convertible note is a short-term debt that eventually converts into equity. Convertible notes operate as loans and are typically issued in conjunction with future financing rounds.

What happens when a convertible note matures?

Most convertible notes, like other forms of debt, provide that they are due at the maturity date, usually 18 to 24 months. Occasionally, convertible notes will provide that at maturity they automatically convert to equity, or convert to equity at the option of the lender.

Are convertible notes treated as equity?

A convertible is a bond, preferred share, or another financial instrument that can be converted by the shareholder into common stock. Convertible securities are not classified as debt or equity; instead, they are considered to be a hybrid of the two categories, possessing cash flow features of both bonds and stocks.

Do convertible notes need to be registered?

Will I need to file a resale registration statement if I issue convertible notes in a Rule 144A offering? No, issuers generally are not required to file resale registration statements with respect to convertible notes issued in a Rule 144A offering, or the underlying shares.

Is Paying Off convertible debt good?

The major benefit of a convertible debt round over an equity financing is speed. We see equity rounds being done faster and more efficiently than ever, but a convertible debt round can still be done faster and more inexpensively.

Are convertible notes short-term or long term?

Summary. A convertible note refers to a short-term debt instrument that allows an investor to convert debt to an equity stake in a company. Convertible notes are typically issued by newly opened companies (startups) and are frequently used in the seed round of financing.

Who issues the convertible note?

A convertible note is a type of loan to a company, which can ‘convert’ into shares in that company if certain events occur. These are called ‘trigger events’. Trigger events include the: company raising another round of funding where it issues shares to its investors (i.e. equity financing);

How are convertible notes priced?

In order to calculate the valuation cap adjusted price per share for convertible note holders, you would divide the valuation cap on the note by the pre-money valuation of the subsequent round and apply that to the Series A price per share.

What happens to convertible debt in an acquisition?

The most company friendly terms call for the note to be repaid with interest to the investor. Most convertible notes call for the note to be converted to common shares in the company at a pre-set price just before the acquisition/merger, often at the same price as the cap of the note.

What is the difference between convertible note and equity?

The difference is that the convertible note is a debt instrument (or loan) that converts to equity. The SAFE simply provides the right to purchase equity at a capped price (possibly with a discount) during a future equity funding event.

Can convertible notes be converted at any time?

A convertible bond is a fixed-income corporate debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares. The conversion from the bond to stock can be done at certain times during the bond’s life and is usually at the discretion of the bondholder.

How do convertible notes affect stock price?

The company issues convertible securities that allow the holders to convert their securities to common stock at a discount to the market price at the time of conversion. That means that the lower the stock price, the more shares the company must issue on conversion.

Do convertible notes dilute?

The stocks that convertible bondholders get when they convert their bonds come in the form of newly issued securities, which can harm previous investors. In the absence of protections, convertible bonds almost always dilute the ownership percentage of current shareholders.

How do I issue a convertible debt?

When a company borrows money from investors and plans to convert it to equity or ownership in the company at a later time, that’s convertible debt. The borrower and lender decide the type of equity and a set time when the loan converts based on the company’s value when the loan begins.

When would you use a convertible debt?

Companies typically take on convertible debt when they believe their shares will increase in value. This allows them to reduce equity dilution (giving up too much ownership). For example, if a business wants to raise $1 million and its shares today are worth $20, it would have to sell 50,000 to reach its target.

Why would a company issue a convertible bond?

Convertible bonds are typically issued by companies that have high expectations for growth and less-than-stellar credit ratings. The companies get access to money for expansion at a lower cost than they would have to pay for conventional bonds.

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