A convertible note is a type of loan that can be converted into equity in a company at a later date. This type of financing is often used by startups and early-stage companies that need to raise capital but are not yet ready to issue equity. Convertible notes can be a great way for investors to get involved in a company with high growth potential, while also providing the company with the flexibility it needs to grow and develop.
If you are considering issuing a convertible note, it is important to use a well-drafted term sheet. A term sheet is a legal document that outlines the key terms of the loan, including the principal amount, the interest rate, the maturity date, and the conversion terms. It is important to have a lawyer review the term sheet before you sign it to make sure that you understand all of the terms and conditions.
There are many different types of convertible note term sheets available online. However, it is important to choose a term sheet that is specific to your company and your needs. The term sheet should be clear and concise, and it should include all of the necessary information.
Key Terms of a Convertible Note Term Sheet
The following are some of the key terms that you should consider when drafting a convertible note term sheet:
Principal amount: The principal amount is the amount of money that you are borrowing.
Interest rate: The interest rate is the percentage of the principal amount that you will pay each year.
Maturity date: The maturity date is the date on which the loan is due to be repaid.
Conversion terms: The conversion terms specify the conditions under which the loan can be converted into equity.
Discount rate: The discount rate is the percentage of the conversion price that the investor will receive at the time of conversion.
Valuation cap: The valuation cap is the maximum valuation at which the loan can be converted into equity.
Negotiation and Execution
Once you have drafted a convertible note term sheet, you will need to negotiate the terms with the investor. It is important to be prepared to negotiate on all of the key terms, including the principal amount, the interest rate, the maturity date, and the conversion terms.
Once the terms have been negotiated, you will need to execute the convertible note. The execution of the note will create a legally binding agreement between you and the investor. It is important to have a lawyer review the note before you sign it to make sure that you understand all of the terms and conditions.
Convertible notes can be a great way to raise capital for your startup or early-stage company. However, it is important to use a well-drafted term sheet and to negotiate the terms carefully. By following these tips, you can increase your chances of success when using convertible notes to finance your business.
