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How Do
CONVERTIBLE NOTES
Work For
Early-stage Financing
What are convertible notes?
A convertible note is:
A financial instrument used for investments in early stage companies
A ...
Best of both worlds
Note holders enjoy the downside protection
typically given to debt lenders, but is also
positioned to ...
Convertible debt is different from equity
In case the company
takes off debt-holders can
convert to shareholders
In case o...
The Trigger Event
*Some contracts have the option to ask for repayment at expiration rather than shares
Subsequent funding...
Basic terms to agree on
INTEREST RATE DISCOUNT CAP
The interest rate is denominated on a yearly
basis.
This rate is usuall...
Debt-holders convert at valuation minus
the discount.
In the case of an early investor, applying
the discount compensates ...
The cap is the maximum valuation debt-holders
can convert at.
The effect of the cap is that convertible note
investors usu...
How to price the convertible notes?
In principle, the higher the valuation at the trigger event, the lower the equity
stak...
How will it affect your cap table?
Convertible note
Cap = $4M
Discount = 20%
Price of convertible note= $120,000 Investmen...
What discount would you give to investors?
Distribution of discount rates by users on Equidam’s Convertible Note Calculato...
Myths of Convertible Notes
It is difficult to issue convertible debt that is not part of a round, because
investors are aw...
Additional Resources
How Do Convertible Notes Work? [Infographic]
Average Discount Rate For A Convertible Note [Video]
Con...
Check out our
Convertible Note Tool
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How Do Convertible Notes Work For Early-stage Financing

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What is the definition of convertible debt and how to use it in early-stage startup financing. You can also see the calculations we made using our Convertible Note Calculator.
To read more take a look at this article: https://www.equidam.com/practical-advice-pricing-convertible-note/
Compute your company valuation for free at https://www.equidam.com/

Published in: Business

How Do Convertible Notes Work For Early-stage Financing

  1. 1. How Do CONVERTIBLE NOTES Work For Early-stage Financing
  2. 2. What are convertible notes? A convertible note is: A financial instrument used for investments in early stage companies A short-term debt that converts into equity at a trigger eventA short-term debt that converts into equity at a trigger event Frequently used in bridge financing Suitable for quick finance injections rather than full financial rounds
  3. 3. Best of both worlds Note holders enjoy the downside protection typically given to debt lenders, but is also positioned to enjoy the upside opportunity presented to equity holders A convertible note- holder enjoys more protection than equity holders in case the company is forced to wind up If the company raises money in a subsequent round, the note-holder converts to equity holder
  4. 4. Convertible debt is different from equity In case the company takes off debt-holders can convert to shareholders In case of liquidation, debt-holders get their money back before shareholders do. SENIORITY SPECIAL RIGHTS
  5. 5. The Trigger Event *Some contracts have the option to ask for repayment at expiration rather than shares Subsequent funding round Take over/sale Liquidation Expiry date of the convertible note Convertible note has a series of triggers for conversion
  6. 6. Basic terms to agree on INTEREST RATE DISCOUNT CAP The interest rate is denominated on a yearly basis. This rate is usually between 4% and 8% from point of signing until the note is converted. As opposed to being paid back in cash, this interest accrues to the principal invested, increasing the number of shares issued upon conversion
  7. 7. Debt-holders convert at valuation minus the discount. In the case of an early investor, applying the discount compensates the investor for the additional risk he bore by investing earlier Basic terms to agree on INTEREST RATE DISCOUNT CAP
  8. 8. The cap is the maximum valuation debt-holders can convert at. The effect of the cap is that convertible note investors usually pay a lower price per share compared to other investors in the equity round. Note-holders convert at valuation equal to cap *(1-discount) Basic terms to agree on INTEREST RATE DISCOUNT CAP
  9. 9. How to price the convertible notes? In principle, the higher the valuation at the trigger event, the lower the equity stake for the convertible note holders, unless the valuation is above the cap. Investors will keep the cap low and the discount high, while you and the founding team will strive for the opposite.
  10. 10. How will it affect your cap table? Convertible note Cap = $4M Discount = 20% Price of convertible note= $120,000 Investment amount = $1M Trigger round Pre-money valuation = $12M *Values are calculated with the Equidam Convertible Note Calculator
  11. 11. What discount would you give to investors? Distribution of discount rates by users on Equidam’s Convertible Note Calculator The average Discount Rate for a Convertible Note is 32,59%
  12. 12. Myths of Convertible Notes It is difficult to issue convertible debt that is not part of a round, because investors are aware that your company probably needs more money than they are offering. In case the convertible note is part of a round, most of the investors will not invest unless everyone else commits and you reach your funding goal. So the immediacy is lost. Negotiations over the cap raise the issue of valuation all over again. You need to get the approval of all current shareholders, which is quite expensive, since you need certification of a notary. QUICK TO ISSUE CHEAP TO ISSUE DEFERS THE VALUATION CALCULATION
  13. 13. Additional Resources How Do Convertible Notes Work? [Infographic] Average Discount Rate For A Convertible Note [Video] Convertible Debt: Risks And Terms To Be Aware Of [Video] Convertible Debt Vs Equity Financing [Video]
  14. 14. Check out our Convertible Note Tool

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