What is Convertible Note Financing?

Financial-300x225

There are many ways for San Jose technology companies to obtain startup financing and fundraising. One way in which private financing and fundraising can be accomplished is through convertible notes, and may or may not require the involvement of traditional venture capital firms. Convertible notes can allow startup companies to determine the amount of control that their investors will have over the management of their company during the initial startup phase. The experienced San Jose corporate attorneys at Structure Law Group can help your startup explore all financing options to advise on which are best for your business.

A convertible note is a form of short-term debt that converts to equity at a specified point in the future. For startup companies, this is most often accomplished by converting an investor’s initial investment into a given number of shares in the company, at a specified round of financing. The equity does not need to be expressed in shares of common stock, nor does it even have to occur during the first round of financing. The note’s terms and conditions can be negotiated to meet the needs of both the startup company and its investor(s).

Other Negotiable Terms of a Convertible Note

It is important for a startup company to carefully consider all the note’s terms. Onerous terms can destroy the financial health of a new startup that is not prepared to meet its convertible note obligations. For example, a “valuation cap” sets a maximum price at which the investor’s notes will convert into equity. While this can provide an incentive for early investors by securing a future form of equity, it can also force a company to convert equity before it is ready to do so. Similarly, a “maturity date” specifies a particular date at which the note will convert into equity. Startup companies must be careful to choose a maturity date that realistically aligns with its financing goals and timelines. Another term that many convertible notes will carry is regarding interest on the principal investment, expressed as additional shares to be issued upon the note’s conversion. The interest shares should be carefully accounted for in order to prevent stock from becoming over-diluted upon conversion of the initial investments.

One of the most common goals of a convertible note is to delay the difficult task of valuing the unknown potential of a startup company. Once the product has been tested in the marketplace and financing events create critical data points, it is easier to determine the fair market value of an early investor’s principal investment. On the flip side, however, it is important to not delay the task of valuation too long. For many investors, the biggest incentive to purchase a convertible note is to be rewarded for early investment in an yet-to-be-proven startup company.

Experienced Representation for Your Business Financing Needs

Assessing appropriate financing solutions is a complicated task for any business. The skilled corporate attorneys at Structure Law Group have extensive experience in assessing lending, fundraising, and other financial solutions. They will work with your business to assess the tools that are right for you and your business. Call (408) 441-7500 today, or email slgadmin@structurelaw.com to schedule your consultation with an experienced San Jose corporate attorney. We fight hard to protect your financial interests.