This minimum amount allows the person holding the note to optimize their return on investment. The amount that will trigger conversion is usually one to two times the principal amount. The exception is if the financing round raises a certain amount of money. Qualified financing: Generally, equity financing will not cause debt conversion to occur. There are three issues that can have an impact on debt conversion: In most cases, the principal amount listed on the convertible note is converted into capital stock when the company that issued the note reaches its next round of financing. Companies typically prefer a later maturity date because it gives them more time to repay the note.Ĭonversion terms are the most important feature of convertible debt. One of the main purposes of a maturity date is to set investor expectations, particularly as they relate to when the equity round will close. For instance, the investor holding the note could decide to receive stock in the company instead of monetary payments when the maturity date arrives. Many convertible notes include repayment options that are beneficial to the investor. The maturity date is the date when the debt must be repaid. Before accepting convertible debt, you should negotiate an interest rate with your investor.Ī maturity date is another important feature of convertible debt. There can be serious tax and accounting implications if you state that your company's convertible notes will not accrue interest. While interest rates for convertible notes used to be between 6 and 10 percent, an interest rate of 1 to 2 percent is now common. You could also decide that compounding interest will convert into company shares instead of principal. The most common option is to pay the interest during debt conversion. Your company will need to decide how you will pay accrued interest on convertible notes. Other convertible debt have a simple interest rate. This means that the interest regularly converts into principal, which then accrues additional interest. Some notes have a compounding interest rate. Interest rates for convertible notes accrue annually for as long as the note is outstanding. Most convertible debt has an interest rate. The principal amount is listed on the convertible note. First and foremost, there is the principal amount, which is the total amount that an investor has invested in a company. Convertible Debt FeaturesĬonvertible debt has a variety of features that you should understand. Unlike other financing rounds, convertible debt rounds can last for an extended period of time, giving investors more opportunity to put their money into the company. Instead of setting a valuation, a conversion discount or a valuation cap will be used. A company in its earliest stages may use convertible debt for fundraising purposes.įor instance, during a convertible debt round of fundraising, the owner of a company can raise capital without completing a company valuation. With convertible debt, the debt will eventually turn into equity for the issuer after certain conditions have been met. What Is Convertible Debt?Ĭonvertible debt functions similarly to normal lending, with one major exception. Convertible debt is very common for startup companies. Debt conversion involves the money that an investor puts into a company with the intention of converting it into equity at a later date.
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