There are a number of scenarios in which a convertible loan can be used. First, it can serve as a source of “bridge funding” prior to a planned major round of funding. Let`s say you`ve raised a $200,000 round and are now in the process of raising $2 EUROS MM Series A, but still need a few months to complete the round. So you take out a convertible loan of 100,000 euros as an additional cushion for the fundraising process. As mentioned above, from a legal point of view, convertible loans are faster to execute, so the entire transaction can be processed in a matter of weeks. Nevertheless, we tend to prefer stock rounds: instead of hiding/avoiding conditions or valuations, we agree on the entire structure at the beginning so that we can focus on the essential: creating value for the startup. You can find more information on how we establish the structure and how we think a fair wordsheet for a fair fairness round should look like in the next article. Startups use convertible notes when the transaction requires speed and simplicity. Since convertible bonds are debt, you can avoid the complications associated with a price reversal in the issuance of shares.
You`ll also need to get a business valuation, which may take some time. The parties should take into account the conversion price and the class of shares in the conversion. The loan is usually converted either at an agreed price or (more commonly) at a discount to the price per share obtained in the eligible financing round. This, of course, would be adjusted in certain circumstances – for example, if the company could issue other shares or options in the period prior to conversion. A convertible debenture (CLN) is a way for a company to raise funds in the form of a loan from an investor – which is converted into equity on a predetermined date or milestone. This can be after the end of a financing round, when the company reaches a certain valuation, cannot repay the loan, is sold or liquidated. But as with any commercial loan (and especially because the loan can be converted into equity), there are a number of key conditions that need to be taken into account and negotiated between the parties involved. Convertible loans involve less documentation and do not require company valuation, as promissory notes are debt securities. Therefore, convertible bonds, when used correctly, can be an efficient, faster and more profitable alternative to equity investments for early-stage companies. The investor can also insist on a valuation cap.
A valuation cap would protect the investor in the event of a sudden increase in the valuation of the investee. The loan would still be converted into equity at the triggering event (i.e., the qualifying round or the specific date), but at a different price depending on the valuation limit. A convertible loan has significant advantages over an equity investment: since a convertible bond is still a type of loan, you need terms like you would with a traditional business loan. Here are the four terms that are important for everyone to understand: The advantage from an entrepreneur`s point of view is that a convertible loan behaves very similarly to a standard loan before it converts: the investor usually does not have many rights from a preferred shareholder (board seats, liquidation preferences, etc.). Since this is a fairly short and simple document, it also executes faster (which is why convertible loan investments can be processed faster than an equity investment, usually by a few weeks). A convertible promissory note is a promissory note that is converted into shares during certain conversion events. Unlike an equity investment, where an investor receives an interest in the company in exchange for cash, an investor who instead provides a convertible loan will provide a loan that has a maturity date, interest, and the right to convert the loan into equity at some point in the future. While this approach is beneficial from an investor`s perspective, it is risky for founders. A post-monetary valuation of €10 million may seem excellent if the company only issues €1 million of convertible bonds before the appropriate funding round, but what if the financing (which may require a certain minimum volume to trigger the conversion) takes longer and the company needs additional interim financing? In this case, if the company receives other convertible bonds in the amount of 2 million euros. In euros issued, the share (guarantee) of the first investor remains at 10%, although the value of the company has just increased by 2 million euros (due to the additional 2 million euros in cash in the bank). .