What is a convertible note?
Start-ups usually raise capital in several financing rounds before they turn a profit. Most entrepreneurs know that raising money is full time job. Pitching and meeting potential investors whenever they can, it would not be optimal to keep these investors warm until the next stock issue. That’s why convertible notes are a great solution to the timing issue.
A convertible note is a loan that converts to equity at the next secondary issue. To compensate the investors for the time lag, and the potential high conversion rate, is is common to give a discount on the conversion rate, and a hard cap. Let us explain:
If you loan company X 100.000 EUR, you will most likely get a 20% discount on the conversion rate versus equity pricing. I you are afraid that the equity pricing is going to be sky high, you might demand a hard cap at 10 millioner EUR. You sign the document and transfer the money the same day. The company can then invest the capital as they see fit, and grow the business until the next equity round.
Six months later the company is issuing equity at 15 millioner EUR. You as the note holder, will convert at the hard cap, which is 10 millioner EUR. In effect you will get 33% more equity than the new investors who participates in the financing round. If the pricing on equity round was 9 millioner EUR, you would convert with a 20% discount at 7.2 millioner EUR.
As you see, a convertible note gives you as an investor a bigger upside and a better deal if all goes according to plan. The company and the entrepreneur can get financing throughout the year and strike when a lead is hot, which often is the only chance they get.
On the BizBot platform you can register convertible notes that your company has issued and soon claim ownership of notes that you have invested in.