A convertible note is a form of debt that has the option to be converted into company shares.
A convertible note is a form of debt that has the option to be converted into company shares. It is often utilized by investors who are financing companies that do not have an accurate company valuation. With the further financing rounds or exit of the company, the convertible note holder will choose if they wish to collect the amount of the note, or convert it into company shares.
To explain better, the convertible note has a structure of a loan. Based on the terms and conditions of the convertible notes, the complete balance would convert into equity when the investor purchases the shares of the corporation.
When a convertible note is evaluated, a few key notes have to be kept in mind:
- Conversion/Discount Rate: This is the discount you get on the total value of the share as per valuation to compensate for the risk of investing earlier.
- Valuation Cap: It caps the rate based on which the notes would convert into the equity. This gives the convertible note holders the benefits of holding an equity if the business succeeds.
- Type of equity interest: Usually, the notes are converted into preferred stock or common stock, though the common stock has some unintended side effects.
- Interest rate: The interest accrues before the conversion at a fixed rate. Nonetheless, the interest is not paid as the debt is paid. Instead, it accrues with the note where it is paid at conversion to the holder.
- Maturity date: This is the date when the note becomes due when the business has to pay it back.
In case you have some questions concerning convertible notes, Eqvista can help in explaining them in details to you. Moreover, our cap table software can help you track all the shares you are giving as equity to investors. So, use our platform today or contact us to get more details!