Learn about Convertible Notes 💵
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Convertible notes are really popular with early stage startups
They are often the very first form of outside capital placed into the company
But why? and how do they work?
Let’s cover all of that…starting with the definition:
➡️ What are Convertible Notes?
They are like a traditional note…
IE someone lends you money, and you get charged interest (often accrued)
But the intention is to “convert” the note to EQUITY
➡️ Why would you want to Debt to Equity?
Well..think about it
Debt is CAPPED
There is a specific amount you are going to get paid
And that can be exciting…
but equity is UNCAPPED
And if you truly believe in the startup…
That difference can be massive
➡️ Why don’t investors invest in Equity from the start?
It all has to do with the valuation of a company
See…every investment works by someone giving $ for a % of the company
HOW MUCH money at WHAT % is all based on the valuation
And early stage startups often times are unsure of their valuation…
so you agree to wait until a large proper equity round with an agreed upon valuation takes place
➡️ How Do Convertible Notes Work?
OK…so at a real basic level
Instead of you repaying someone with MONEY
You pay them with EQUITY
That’s really all a convertible note is…
But there are a few nuances:
♻️ Convertible Notes convert upon certain “QUALIFYING” activities
A qualifying activity for a convertible note is most commonly whenever you have a round of financing greater than a certain amount
🤑 Convertible Note Holders get preferential terms when the note converts
Because the note holders took on the risk with their initial investment…which easily could have defaulted
They now get a little kickback
That’s often times by investing at a CAPPED (lower) valuation
or via a DISCOUNT on the share purchase price
The beauty of it is that investors get to choose between the higher of those 2 when the time to convert takes place
➡️ OK, can we put that all together?
A Convertible Note
Is a loan given by an investors
It starts off as DEBT
and accrues INTEREST
but the intention is to convert it to equity upon a QUALIFYING event
and when that QUALIFYING event happens…
investors get to purchase shares at a favorable rate
In exchange for the risk
That’s my take on convertible notes 👆