What’s a Convertible Note?
Today we’re going to talk about startup funding and one of the ways that you can do that is through something called a convertible note and there’s a lot of confusion over how a convertible note works.
When companies are raising capital to expand their business they have two ways of going about it. They can either take out loans from the bank, friends, or family or they can issue equity in their company.
What a convertible note does is it blends those two different models. So what a convertible note is it’s a short-term loan or a short-term debt instrument that has the option of being converted into equity at a later point in time. So when an investor first agrees to provide your company with a convertible note they are essentially providing you with a short term loan that can be later converted into Equity into shares in your company. So it is a lone instrument that has all of the normal features that you would associate with a loan, it has an interest rate attached to it and that could be anywhere from 0 to 20% and it has a maturity date.
The loan will become due and will be repayable by the company back to the investor after a certain period of time couldbe anywhere from one to five years sometimes shorter sometimes longer.
How the convertible part works is that when the note reaches the date of maturity the investor will have the option of that point to either convert the value of the loan into shares in the company or to ask for the full value of the loan to be repaid and the benefit for the investor here is that the note will also have a discount attached to it
The main benefits for the company using convertible notes are twofold –
You can still retain all the equity in your company. So you’re not having to issue any of the shares in your company until a later point in the future and you can choose to repay the loan instead of issuing shares in the company depending on the language that’s used in the convertible note.
It’s a complex topic, and if you have any questions, please feel free to drop them below and be sure to subscribe to the YouTube Channel.