Convertible Promissory Notes
$10M Valuation cap|15% Discount|6% Interest
12/31/2020 maturity date
Minimum $350 Investment
Notes convert to common stock when the company raises $1,000,000 in a qualified equity financing
Maturity Date: 12/31/2020
Valuation Cap: $10,000,000
Discount Rate: 15%
Annual Interest Rate: 6%
Maximum ($1,070,000) of Convertible Promissory Notes
Minimum ($10,000) of Convertible Promissory Notes
******************EVERYTHING BELOW THIS LINE IS BASED ON OUR RESEARCH AND UNDERSTANDING. IT IS OUR OPINION ONLY, AND ENCOURAGE YOU TO EDUCATE YOURSELF ON THE DETAILS OF CONVERTIBLE NOTES AS A FINANCIAL INSTRUMENT BEFORE DECIDING TO INVEST. **************************
What is a Convertible Note?
A convertible note is short-term debt that converts into equity. Convertible notes are structured as loans with the intention of converting to equity. The outstanding balance of the loan is automatically converted to equity at a specific milestone, often at the greater valuation of a later funding round.
Why do startups raise investment capital using convertible notes?
Convertible notes (or “notes”) offer a simple, cheap, and fast method for startup funding as compared to traditional priced equity rounds. It also defers the more complex discussion of startup valuation to the next round of financing.
What does the maturity date indicate on a convertible note?
The maturity date of a note indicates the date when the note is due to be repaid to the investor along with any accrued interest, if it has not yet converted to equity.
What is a cap in a convertible note?
A convertible note cap sets the maximum valuation at which the investment made via the convertible note can convert into equity. Investors in the convertible note typically get converted at the lesser of the valuation of the next qualified priced round and the cap.
What does the interest rate indicate on a convertible note?
The interest rate of a convertible note indicates how much interest accrues to the investor prior to the note’s conversion to equity or its repayment as cash when called.
On the west coast in the US, we believe typical interest rates on most convertible notes are a nominal 2% (and cannot legally be lower or they might not be viewed as a convertible debt instrument). Elsewhere in the US, we believe typical interest rates on most convertible notes range from 4-8%.
For example, with an interest rate of 6%, $100 invested on day 0 would convert as if $106 had been invested on day 365, if conversion happens on day 365.
From an investor standpoint, the interest rate term is not as impactful to startup returns as picking the right startups to fund, and as other convertible note terms such as the conversion cap and/or discount rate. Investors use this instrument with the intention of converting to equity, as opposed to making a return on the interest.
What happens to a convertible note if a company shuts down and goes out of business?
As holders of a debt instrument, holders of convertible notes come ahead of holders of equity in terms of repayment of any remaining assets they may have a claim to during liquidation. In concept, the holder of a convertible note will be paid ahead of all equity holders.
What happens to a convertible note if a company is acquired or merges with another company?
If a company is acquired or merges before a convertible note converts, the specifics of what a noteholder receives will depend on the specifics of their convertible note terms. The most company friendly terms call for the note to be repaid with interest to the investor. Most convertible notes call for the note to be converted to common shares in the company at a pre-set price just before the acquisition/merger, often at the same price as the cap of the note. Still others call for the noteholders to be paid back their principal investment plus interest, plus a premium amount, generally 0.25-1.5x of principal.
Does a convertible note holder have a choice about converting a note in an equity financing round?
The terms of conversion are usually listed in the convertible note. Typically, conversion to equity is automatic at the next equity raise, but may be conditional on a round meeting certain thresholds such as a minimum round size.
The Specifics about this Convertible Note
The number of shares you will receive in the future will be determined at the next equity round in which the Company raises at least $1,000,000 in qualified equity financing. The highest conversion price per share is set based on a $10,000,000 Valuation Cap or if less, then you will receive a 15% discount on the price the new investors are purchasing. You also receive 6% interest per year added to your investment. When the maturity date is reached, if the note has not converted then you are entitled to receive common stock equal to your investment and interest back at a price per security determined by dividing the Valuation Cap by the aggregate number of outstanding shares of the Company as of immediately prior (on a fully diluted basis), subject to the discount rate, if applicable.