The convertible notes can be described as a short term loan that the holder can easily convert into equity in the company that has issued it. These notes are usually used by new investors who have just started investing in startups. It gives them the time to decide the worth of a company till they are ready to perform an easy valuation. With the help of convertible notes, the investors loan money to the start-up and in exchange, they take shares of the company as opposed to principal payouts along with the interest.
One of the main reasons why startups prefer to use a convertible loan note is because they are easy to use and fast. With these notes, the companies can avoid the complicated procedure of actually issuing the stock shares. Also, if you are up to providing fundings for a startup, it is important to perform a full valuation of the company. This procedure can be difficult in the initial business phase, like in the pre-revenue time or when the company is looking for funding that will help them build the concerned technology which they can sell in the market and get profits.
There are several advantages of getting a convertible loan note, like:-
- The procedure is very fast and simple. It helps the startups to get the required fundings with a promissory note. There are no complicated procedures involved.
- Another good thing about these convertible notes is that they help in delaying valuation. This is a good point for startups who did not yet have a transaction in terms of revenue or products. The companies, in this case, can push back the valuation process by giving the early investors a considerable discount on the securities.
- With convertible notes, the startups will not have to think about making any type of payment to the investors. This improves their cash flow and also enhances their overall operations.
Convertible notes are ideal for startups who have just entered the market. Investors would be interested in these notes if a start-up company is in a high-growth phase. The company would need to talk to new investors telling them that when they are ready for funding, the business will have a valuation and convertibles will not be a concern for them.
Also, it is essential to remember that these convertibles are debt before equity so the startups need to grow really fast. Timing is crucial because if the notes mature, then the startup will have to pay the principal amount back with interest if the investor doesn’t agree to extend the maturity date.
It is a great way to fund your business in a secured environment, quickly. The promissory note does not need a detailed term sheet like an agreement.
