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Learn about Convertible Notes 💵


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?


Yes -


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 👆

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