1. CONVERTIBLE NOTES: WHAT ARE THEY?
You may be thinking about raising capital from investors.
Ever wondered what a convertible note is and what benefits it holds? Let’s start by understanding what it actually is.
2. KEY TERMS & DEFINITIONS ON THE TOPIC
Standard convertible note terms are parameters for short-term business debt.
A convertible note will convert into equity at a future date, meaning that the investor loans money to an entrepreneur and receives equity in the company rather than payments on the principal plus interest.
Get a grasp some of the main and common terms to keep in mind as you explore the topic using this infographic:
3. QUIZ TIME: HOW MUCH DO YOU KNOW ABOUT CONVERTIBLE NOTES?
Before going further – time to test your knowledge on convertible notes!
To make discussions with investors easier, any founder should understand this basic financial instrument.
So how much do you already know about the topic?
Test your knowledge by taking this short quiz.
4. CONVERSION EVENTS
Investors who loan the company funds have a right to recover their loan amount - usually with interest - and convert it into shares - usually at a discounted rate- when certain pre-agreed trigger events occur.
Now the question is, when does the conversion take place? And what are the events that trigger this conversion?
CONVERSION METHODS: HOW DOES THE NOTE CONVERT INTO EQUITY?
There are 3 different calculation methods to calculate the price per share to which a note converts at, each differing in the variable being fixed:
5. [METHOD 1] – THE PRE-MONEY METHOD
In the pre-money method, the pre-money valuation, or the company valuation that is determined during your equity round before receiving any financing, is the variable that gets fixed.
This allows you to calculate the price per share, which in turn helps you find the number of shares the convertible note holder and the new investor will eventually receive.
6. [METHOD 2] – THE PERCENTAGE OWNERSHIP METHOD
The Percentage-Ownership Method is known as the investor-friendly method. The fixed factor is the percentage ownership that the new investor is purchasing.
7. [METHOD 3] – THE DOLLARS-INVESTED METHOD
The third method, the dollars-invested method is often used as a compromise between the pre-money method and the percentage-ownership method.
In the dollars-invested method, the fixed factor is the effective post-money valuation of the company which takes into account the money invested by the note holder.
9. FINAL QUIZ: ARE YOU READY TO USE A CONVERTIBLE NOTE?
So now that you've gone through the series – what are the first steps to issue a convertible note? And how and when does one go about converting this investment into equity?
All in all - are you really ready to get started on convertible notes?
Take this quiz to find out!
10. GET STARTED & DOWNLOAD THE HUB'S CONVERTIBLE NOTE CALCULATOR TEMPLATE
Generally, the percentage ownership is most often used, as new incoming investors have the most leverage. But founders and business owners must understand the difference between each method so they can negotiate a deal that works for all parties.
It may seem complicated at first, but don’t worry!
Use this Convertible Note Calculator and find what works best for your company!
WHAT DID YOU THINK?
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