Using Convertible Notes for Financing a Startup

I’ve been doing some research on the use of convertible notes for the purposing of financing our startup, BiggerPockets.com. If you’re also doing research on this financing option, I hope you find the info helpful — if you’ve got some great articles that you want to share, please do in the comments below.

Without further blathering, here are a few articles that I’ve discovered, followed by a key quote from that piece:

• What’s The Best Structure For A Pre-VC Investment? – FeldThoughts
  

  Assuming that you are planning on raising VC money some time in the future, there are two different typical structures for the first angel financing: (1) convertible debt and (2) preferred equity.

• What are the benefits of debt in a seed round? – VentureHacks
  

  When your business is very young, raising a seed financing ($50K-$500K) via convertible debt is a great alternative to selling equity. Convertible debt is also known as a bridge loan since it ‘bridges’ the company to its next financing.

• Raising Money Using Convertible Debt – Entrepreneur.com
  

  To boil it down, using the convertible debt method of financing with family, friends and angels essentially boils down to you saying, “I need money, and you have it. But I don’t know how much my company is worth, so let’s see if professional investors or the passage of time will set the value for us while giving you an upside that’s more in keeping with the risk.”

• What Happens If Convertible Notes Are Called By Angel Investors? – AsktheVC.com
  

  One thing to note: don’t personally guarantee angel notes. In that case, the calling of the notes will attach to the entrepreneur’s personal assets and may indeed incentivize investors to call their notes sooner than later.

• What happens to the convertible promissory note if the maturity date is reached and there hasn’t been a financing? – startupcompanylawyer.com
  

  The company could either (1) pay back the loan (which is unlikely since it is probably out of money), (2) ask the investors to extend the maturity date, (3) convert the loan into the last round of Preferred Stock (if any) at a pre-determined (i.e. last round) price (or price negotiated at the maturity date), or (4) convert the loan into Common Stock at a pre-determined price (or price negotiated at the maturity date). If the company can’t repay the note, then the investors could push the company into bankruptcy.

• Should Entrepreneurs Be Worried About Convertible Notes as a First Financing Event? – AsktheVC.com
  

  Pros: It is much cheaper to consummate a note deal, than a financing deal, which also means it is much quicker to close. Also, you don’t have to lock in a very low valuation today and if you do well the notes should convert into a higher valuation than they would have if you have done an equity deal.

• Supersize your debt with these microhacks – venturehacks.com
  

  Note that the company makes the decision to convert the debt to equity—not the investors. This term lets the company avoid defaulting on the loan.

• How Do I Do Multiple Closings for an Angel Round? – AsktheVC.com
  

  For a convertible debt round, you can keep it as simple as issuing a promissory note for each investor. This promissory note can contain any special conversion terms, including what happens on a qualified financing (including the definition of the qualified financing), what happens on a sale of the company, and what happens if the company fails. You can do as many closings as you want by simply issuing a separate promissory note for each investor.

  Additional reads:

  • Convertible Notes for Angel Investing
  • Exchangeable Shares for Angel Investors
  • Angels: Don’t Use Convertible Debt to Fund Startup Ventures
  • Startup FAQ

  Related posts:

  1. Funding a Startup with Angel Investors or Venture Capital
  2. Planning for the Unexpected and Startup Team Building

  Tagged as: angel investor, convertible notes, debt, startup financing, VC