What is the meaning of convertible note?

A convertible note is a debt instrument often used by angel or seed investors looking to fund an early-stage startup that has not been valued explicitly. After more information becomes available to establish a reasonable value for the company, convertible note investors can convert the note into equity.

What is the benefit of a convertible note?

The main advantage of using convertible notes is that they don’t have to valuate the company until the Series A round of financing — when there’s more data to base the company’s valuation. Valuations are challenging in a company’s early stages because there aren’t enough data to reasonably determine a startup’s worth.

How does a convertible debt work?

With convertible debt, a business borrows money from a lender where both parties enter the agreement with the intent (from the outset) to repay all (or part) of the loan by converting it into a certain number of its common shares at some point in the future.

What happens when a convertible note converts?

Generally, convertible notes convert into shares (the “Conversion Shares”) at a qualified equity financing round (this term should be defined in the note and usually means a preferred financing round of a minimum size) at the lower of two different prices per share: (1) the price per share using the conversion cap ( …

Do investors prefer convertible notes?

It can be difficult for new investors to establish whether the terms of a particular note offering are fair, driving some away from deals financed with convertible notes. Some investors prefer to wait until a priced round, even while acknowledging they will most likely pay a higher price.

Why do investors buy convertible notes?

Companies issue convertible bonds to lower the coupon rate on debt and to delay dilution. A bond’s conversion ratio determines how many shares an investor will get for it. Companies can force conversion of the bonds if the stock price is higher than if the bond were to be redeemed.

Why does Shark Tank not use convertible notes?

In India, issuing convertible notes to foreign investors was always forbidden since the Reserve Bank of India (RBI) and the Ministry of Commerce and Industry (MoCI) allowed foreign direct investment (FDI) only in equity instruments or such other instruments that were considered at par with equity (compulsorily …

What happens when a convertible note matures?

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.

Do convertible notes have to be paid back?

Convertible notes are just like any other form of debt – you’ll need to pay back the principal plus interest. In an ideal world, a startup would never pay back a convertible note in cash. However, if the maturity date hits prior to a Series A financing, investors can choose to demand their money back.