Are convertible notes good for startups?
Convertible notes are a convenient method of raising capital, especially for startups because issuing them does not require company valuation. This works perfectly for startups as in the initial stages, a startup is just an idea. Hence, seed funding using convertible notes is quite a convenient option.
What is a convertible note for a startup?
A convertible note is an investment vehicle often used by seed investors investing in startups who wish to delay establishing a valuation for that startup until a later round of funding or milestone. Convertible notes are structured as loans with the intention of converting to equity.
Why do startups use convertible notes?
Startups and investors choose to use convertible notes because they’re simple and fast. Since convertible notes are a type of debt, they give you the ability to avoid the complications of a priced round where you actually issue shares of stock.
Are convertible notes a good investment?
Convertible notes avoid placing a valuation on the startup, which can be useful particularly for seed stage companies which have not had enough operating history to properly set a valuation. Convertible notes are good bridge-capital or intra-round financing options.
Why are convertible notes bad?
When Convertible Notes Are Bad Convertible notes are destructive when used carelessly. Having too many notes or poorly structured notes outstanding can put your company and later negotiations at risk by complicating your cap table.
What is the benefit of convertible notes?
The main benefit of a convertible note is their relatively simple structure. Startup financing rounds can quickly become complex and take up significant time and money. Convertible note financings tend to be faster, simpler, and cheaper than priced rounds.
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.
Is safe better than convertible note?
A convertible note is debt, while a SAFE is a convertible security that is not debt. A SAFE is simpler and shorter than most convertible notes. Both SAFEs and convertible notes convert into equity in a future priced equity round; a convertible note may have more complexity to when/if/how it converts.
What happens to convertible note if startup fails?
When a startup fails, the company typically has run out of money. The owner of a convertible note may get nothing, or at best may only receive pennies on the dollar. You also may be able to write off your loss.
Are convertible notes bad?
So at the end of the day, convertible notes (and other deferred pricing structures like SAFEs) are not good for investors and they are also not ideal for entrepreneurs. Their defects tend to get over-looked in very small rounds because they are a cheap and easy transaction to do.
Are convertible notes SAFE?
While convertible note is a debt, a SAFE note is not debt: a convertible note includes an interest rate and maturity rate, a SAFE note doesn’t. Both SAFEs and convertible notes convert into equity in a future priced equity round; a convertible note may have more complexity to when/if/how it converts.
What happens if you can’t pay a convertible note?
And that later date brings up an issue: what happens to that convertible note if a startup fails? When a startup fails, the company typically has run out of money. The owner of a convertible note may get nothing, or at best may only receive pennies on the dollar. You also may be able to write off your loss.
How does a convertible note work for a startup?
Blog > Startup Investing. A convertible note is a form of short-term debt that converts into equity, typically in conjunction with a future financing round; in effect, the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.
When to use convertible notes for seed funding?
For most seed companies, convertible notes and equity are the main options. For rounds above $1-1.5MM+, equity (particularly seed equity) should be given strong consideration. We are also seeing more founders and investors who really prefer equity opting for seed equity docs for rounds as low as $500K.
How much interest is accrued on convertible notes?
In a qualified financing that occurs 18 months after the convertible notes are sold, the company sells equity at $3.50 per share. At this point, the notes will have accrued $3,000 in interest, making the amount owed to the note investor $28,000.
What are the pros and cons of convertible notes?
Jeff is an M&A and VC financing expert, having led three acquisitions and six VC investments at Seagate, a private investment group. Between 2010 and 2016, the volume of rounds including debt instruments has grown c.4x. Particularly for seed rounds, convertible notes have become the preferred fundraising instruments for many startups.