Convertible note or convertible debt

Equity Term

Sometimes a young, seed stage company wants to raise a relatively modest amount of money quickly and defer the question of valuation – how much the company is worth – in which case it may raise investment in the form of a convertible note, sometimes called convertible debt. This security is structured as debt in the short term but is designed to convert into the next round of equity, meaning it will (usually) convert into convertible preferred shares.

As debt it has an interest rate but generally that interest is accrued (not paid but accumulated) until both principal and interest convert into equity. It also has a term at the end of which it must be repaid, or depending on how the note is written, converted in equity using terms specified in the document.

Convertible notes are used a lot but there are many investors who don’t like them, some to the point they won’t invest in companies using convertible notes. See for example: Mark Suster (“Both Sides of the Table”), Christopher Mirabile (President of the Angel Capital Association).

Don Gooding

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