Securing funding for your startup business is never easy – but hopefully, we can give you some guidance on using convertible promissory notes in your funding rounds. These notes have been rising in popularity with startups in the past few years, and, for many, have proven to be an effective means of garnering startup funds. If you’re seeking the money to get your business rolling, these notes may be your path forward.
Why Consider a Convertible Promissory Note?
Convertible promissory notes are named as such because they are intended to eventually convert the original investment into equity in the company. This form of delayed equity provides plenty of benefits to both investors and business owners, which is why they’ve become significantly more popular. To start, an investor provides investment funds, which earn interest. Second, this security allows both the investor and the Company to defer the difficult issue of the Company’s valuation. Often, these securities are used early in the Company’s life and, as a result, valuation is both uncertain and lower than the value at which the company would want to place its equity.
Maturity Date Benefits
Like all promissory notes, a convertible promissory note has a maturity date (i.e., the date on which the debt must be repaid). But, typically, the company is hoping that one or more events occur prior to the maturity date, making the maturity date a moot point. The typical plan is for these funds to be used as seed capital and to “bridge” the Company until it can seek a larger investment amount at a higher valuation. Thus, the Company typically intends to solicit a larger equity round of investment prior to the maturity date. In such an event (usually defined as a “Qualified Financing”), the convertible notes will convert their loans into the equity in the Qualified Financing round, typically at a discount or maximum valuation of the Company (the “valuation cap”). The discount and/or valuation cap provide the convertible note-holders with a benefit for their earlier (and therefore, riskier) investment in the Company.
Plan For The Unintended Outcomes
In addition to planning for the desired plan and outcome, a well structured convertible note will also plan for the unintended outcome (e.g., the Company isn’t able to raise a Qualified Financing or otherwise realize a liquidity event prior to the maturity date). Thus, the Company should consider what will occur upon a liquidation of the Company and/or the maturity of the loan. In the case of a liquidation (particularly, a sale of the company), it’s not uncommon for convertible note holders to receive a premium over their stated loan amount to compensate them for their investment and the fact that they did not get to convert into equity prior to the liquidation, In the case of maturity, the loan may simply come due and be payable to the lender. In other cases, the Company may pre-negotiate the terms of conversion of the debt into equity.
Let Us Help. Call Us Today.
Convertible promissory notes remain a great option for the emerging entrepreneur, as long as the terms of their conversion are clearly laid out and you remember the specifics of the agreement. For startups quickly gaining traction and pulling in revenue, they can be a quick and effective way to get the capital you need to keep growing. The next thing you can do to help your business is call us – whether you’re seeking assistance with raising capital, growing your business, or need general counsel, Doida Crow Legal is here to help. To schedule your consultation, call us today at (720) 306-1001 or email info@doidacrow.com.
Related Reading
- Convertible Notes In Startup Financing: Basic Terms & When to Use
- Is It Important To Hire A Lawyer For Startups?
- Crowdfunding Startups: Investing for the Masses