TechCrunch+ roundup: Convertible note fundraising, fintech's falloff, how to mark-to-market | TechCrunch (2024)

FAQs

What happens to a convertible note if startup fails? ›

If a company raises money on a note and the company fails, the investors are creditors, getting money back prior to any shareholder and any creditor that doesn't have security or statutory preference. In almost every case, convertible note holders in these situations would be lucky to get pennies back on the dollar.

The basic concept for valuing a convertible note is the same in theory as the valuation of any other financial asset. The value of the note is equal to the present value of the future income that the convertible note will receive, discounted to the present value based on its associated risk.

Pre-money or post-money? Convertible notes can be designed to convert pre-money or post-money. In the next funding round, the notes might be set up to convert before any new investor's stake is accounted for, meaning the value of the note is included in the pre-money valuation in financing discussions.

The general accounting treatment of a convertible note involves initially recording it as a liability on the balance sheet. Over time, interest will accrue, and any potential conversion into equity should be accounted for when the conversion event occurs.

If the convertible note has not converted prior to the end of its term due a financing or sale of the company, the best option is usually to extend the term of the note for an additional year. Investors commonly use convertible notes to invest in startups because they are inexpensive and quick to draft.

The terms of your convertible notes will usually require the company to notify the noteholder prior to entering into documents to give effect to an exit event. Usually, the noteholder can choose whether they want to: recover their loan amount (plus any interest) in cash; or. convert that amount into shares.

The conversion value is calculated as the product of the conversion ratio and the market price of the issuer's common stock. Upon multiplying the conversion ratio by the market price per share, we estimate the convertible value – the value of the common shares received post-conversion – to be $1,200 per bond.

A convertible note is a financial instrument, based on contract law, and as such it is a property right. All property rights can be bought and sold, provided there is no clause in the private contract between the original parties forbidding it.

The following are just a couple of the possible disadvantages of using convertible notes as a financing mechanism. If they don't convert, the notes eventually come due. This can result in the end of the startup if the note holders aren't willing to negotiate, and the startup doesn't have the means to pay off the notes.

Conversion Provisions: The primary purpose of a convertible note is that it will convert into equity at some point in the future. The most common method of conversion occurs when a subsequent equity investment exceeds a certain threshold.

How to convert a convertible note? ›

Generally, convertible notes convert into shares (the “Conversion Shares”) at a qualified equity financing round (this term should be defined in the note and usually means a preferred financing round of a minimum size) at the lower of two different prices per share: (1) the price per share using the conversion cap ( ...

Apply the desired ownership percentage: Multiply the post-money valuation by the desired ownership percentage to determine the valuation at which the convertible note will convert into equity. This value represents the valuation cap.

A convertible note should be classified as a Long Term Liability that then converts to Equity as stipulated from the contract (usually a new fundraising round).

A convertible note is a type of debt financing a startup can use to raise money. It is an agreement between the company and the investor to convert the note into equity at a future date. The company will receive cash now. In return, they will give the investor shares of stock at a future date.

An investor lends money to a startup in exchange for a convertible note. This is a convertible debt that the startup agrees to repay, usually within 2-5 years. Before the note comes due, the investor has the option to convert the debt into equity shares in the company, like stock.

Unlike a bank loan, which is commonly personally guaranteed, the founders aren't personally on the hook. Fourth, investors in convertible notes don't typically get control provisions (e.g., blocking rights on a sale or future financing) or board seats.

Maturity Date

Unlike a car loan or student loan, convertible notes don't have set monthly payments. Instead, the company generally has to repay the full amount—the principal plus interest—at the maturity date if it does not convert first.

Ambiguity – Since convertible note investment is done mostly with startups, a common risk investors face is the failure of repayment. If the startup cannot raise subsequent equity financing, the business will not have sufficient capital to repay loans.