Are convertible notes good for startups?

Convertible notes avoid placing a valuation on the startup, which can be useful particularly for seed stage companies which have not had enough operating history to properly set a valuation. Convertible notes are good bridge-capital or intra-round financing options.

Is it bad when companies issue convertible notes?

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.

What is the main advantage of a convertible note?

A convertible note allows for no valuation or share price to be set, instead a discount or coupon can be used on the note. This discount or coupon is that converted at a later date into equity, typically at the next round of funding.

Why would a company issue notes payable to pay off convertible debt?

Why Do Companies Offer Convertible Senior Notes? Convertible notes and convertible senior notes are a popular way for companies to borrow money with lower interest obligations than other kinds of debt. When note-holders redeem their notes for company shares, they reduce the company’s debt obligations.

Are convertible notes debt or equity?

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 are the risks of convertible notes?

Ambiguity – Since convertible note investment is done mostly with startups, a common risk investors face is the failure of repayment. If the startup cannot raise subsequent equity financing, the business will not have sufficient capital to repay loans.

What happens to convertible notes at maturity?

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 considered debt?

What is a convertible note startup?

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.

Why do Startups use convertible notes?

Unfortunately, valuation is a complex issue, which is why many startups who raise angel or seed capital choose to use convertible notes when engaging investors. A type of financing for early-stage companies, many startups use convertible notes before they pinpoint an exact valuation for their organization.

Why don’t startups raise money with convertibles?

Because raising money with convertibles notes means there’s no valuation, then there’s no possibility of a down round. When a startup raises debt in the form of convertible notes, they retain control of their company.

When does the interest accrue on a convertible note?

The interest accrues until the startup has their Series A valuation, at which point it is converted into shares for the investor. The maturity date on a convertible note is the “times up” date. If a startup doesn’t manage to raise a Series A, the maturity date is the day that they have to repay the investor, interest included.

Why do founders have to pay lawyers to issue convertible notes?

That’s because founders have to pay lawyers to work out the deals of the note and the deal when the note converts to equity. While convertible notes are simpler than Series A rounds, simple agreement for future equity (SAFE) is even simpler than convertible notes.