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A Summary of

All You Need To Know About Convertible Debt

by
Ariella Young
Ariella Young
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Types of convertible debt

  1. Convertible equity debt
    1. An investor loans money to a startup (usually pre-revenue early-stage companies) in return for equity in the company at a later time
    2. Usually include additional, equity-like, perks for investors
    3. If a company fails to receive a follow-on round, investors can’t ask for the redemption of the debt
  2. Traditional convertible debt
    1. The price of the stock is not determined at the time when the investment is made

Get into convertible debt if you

  1. Want to value your startup later
  2. Need cash fast and don’t want to be valued before gaining traction
  3. Board control is important
  4. Don’t want to dilute shares for investors
  5. Have a sophisticated investor with experience

To negotiate convertible debt consider

  1. Discount rate 
    1. Investor can convert the loan into shares at a discount compared to the purchase price paid by the investors during the follow-on round
    2. About 20%, +/- 5% to 30%
  2. Interest rate
  3. Maturity date 
    1. Usually, investors won’t ask to be paid back on the maturity date and extend it if there is no subsequent equity round
  4. Pro-rata rights
    1. Let investors keep their equity stake by investing in further financing rounds
  5. Conversion cap
    1. Sets the maximum company valuation at which point the note will convert into equity.
    2. Investors will
      1. Pick a cap; or
      2. A discount rate if the next round is below the cap
  6. Warrant
    1. Used by a warrant holder to acquire shares from the borrower at a pre-determined price 
    2. For late-stage startups with a raised round of equity
    3. When issuing warrants think of
      1. What percentage of your startup the warrant will represent; and
      2. Which class of stocks you will be issuing
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