It can be tricky to get access to capital and grow your business, especially when your business is in its early stages. Many investors are hesitant to put money into companies that do not have a history of growth or revenue. However, there are options you can consider. One of the most common ways early-stage companies raise money is with convertible notes.
A convertible note is an investment that lets founders raise money from investors without conducting a formal company valuation first. It is a short-term debt that has the potential to convert into company equity at a later date.
Though valuations can give you a better idea of your company’s worth and growth potential, they also force you to put a price on your stock. That’s why many founders like the idea of convertible notes; you have more time to see how your company will evolve before setting a price per share.
If an investor believes in your company, they can give you a loan in exchange for a note in the form of convertible debt. It then turns into shares of preferred stock upon a qualifying event or transaction.
Convertible notes are designed to reward early investors for their risk which is why they come up with a conversion discount or valuation cap. A conversion discount gives investors a discount on the price per share when their note converts into equity. A valuation cap sets a maximum valuation which an investor’s money can convert into equity. It determines the price per share and holds true for convertible noteholders even if later-stage investors pay a different price.
A convertible note that has not been converted to equity by the time expires, you need to pay back your investor’s principal investment plus interest.
There are both pros and cons of using convertible notes to finance your company’s growth.
It can be complicated to fundraise for your company so it is important that you gather as much information as you can about the options that are available. Make sure you take time to review your goals, discuss strategies with your team and read up on the fundraising market for the type of industry you are in.
No matter what you choose make sure that you carefully weigh your options to determine what makes most sense for you company’s immediate and long-term growth.