A convertible note is a financial instrument small companies use to raise early-stage capital. You could think of a typical convertible note as an IOU (a document that acknowledges a debt). You don't pay in cash only this time; you pay in equity (or company shares).
With so many misconceptions about the convertible notes, it's easy to misunderstand many things when it comes to handling them. However, if you're looking to maximize your start-up company's capital, you need more detailed information about convertible notes. Here are seven things you didn't know about convertible notes.
Your Investors Are Safe With the Convertible Notes
If you're worried about losing your initial investors when the new ones come in, the convertible note's got that covered. Using the convertible notes with all your investors permit the ones who initially believed in your company an interest rate of about 5%-6% on their investments and a discount rate of about 20%-25% on stocks' valuation. This way, you can keep all your investors happy.
The Convertible Note Allows You a Maturity Date
Suppose your company doesn't make as many sales as you projected during start-up. In that case, your convertible note investors allow you a set period to mature your company before any repayments are made. You could think of this as a grace period to do the needful and increase your company value, so you don't run out of business.
Using Convertible Notes Grant You a Repayment Schedule
In a case where you need to pay the CAP (Customer Approved Payment) for your investors, the convertible notes allow you to pay in installments. This is better than having to off all your investors all at once.
Convertible Notes Are No Longer Designed as Investments for Debts
Convertible notes were initially designed as debt investments, but now, they have a structure that lets the principal and the resulting interest be converted into an equity investment at a later time. This feature allows the original investment to be made faster with lesser legal fees for the company. This gives investors the actual operating exposure of the investment.
Convertible Notes Are More Comfortable to Document from a Legal Perspective
Did you know convertible notes are much cheaper than a legal perspective? Did you also know that it is quicker to close rounds on convertible notes? This is because the company investors put off some trickier features to a later date.
Convertible Notes Allow the Company to Delay Placing a Value on Itself
If your company's still at the seed stage and you hadn't had the time to display much traction in terms of revenue or product, using convertible notes to bring in investors to your brand gives you the brevity to delay valuation. This is particularly important, so you don't rush things with your company. In place of letting investors have a deduction on the actual price to be set later, your company can have that decision at a later time.
Using Convertible Notes Comes With Low-Risk – Also Highly Efficient
Compared to conventional notes to investors, issuing convertible notes to your investors do reduce the risk of rushing things. As said earlier, investors garnered through convertible notes aren't obligated to demand company valuation at the beginning of the start-up. This allows you to plan everything about your company accordingly while taking into consideration other factors like sales, ROI, marketing, etc.
The convertible note is a fool-proof investment plan for start-ups. However, take care not to forgo other factors surrounding the use of convertible notes. If you're having doubts about setting up convertible notes for your start-up company, ask for help.