When you think of the word “convertible”, an image of a sleek sports car cruising the Miami Beach strip likely pops into your mind. Unless you are a business looking to raise capital; in that case, “convertible” takes on a whole new meaning.
What are Convertible Notes?
Convertible notes are a way that a company can raise capital, generally in an early stage of its existence. Traditionally, people think of investments as putting money in and receiving stock back. However, when dealing with convertible notes investors loan money to the startup as its first round of funding. Rather than get their money back, the investors receive shares of preferred stock as part of the startup’s initial preferred stock offering. Or, in other words, the notes CONVERT into preferred stock at a later date.
Why Use Convertible Notes?
There are many advantages of using convertible notes to raise capital in the early stages of a company.
- The notes allow for the valuation of the company to be delayed until the eventual Series A offering. It is advantageous to a company not to have a valuation too early, for tax purposes and investment terms for the note holders.
- Further since convertible notes aren’t an actual issuance of stock, as we mentioned earlier they are a LOAN, the offering of such notes is generally quick with minimal legal expenses incurred.
- The greatest advantage of convertible notes is that they are completely customizable. Meaning one note can have totally different terms to another. The terms of the note can be determined per individual whereas in an offering of preferred stock, the terms must be autonomous throughout the round for each investor.
Convertible notes can be a useful tool for companies ready to take steps towards becoming a viable, scaling business.
For more ideas on raising business capital, check back here soon!