Convertible debt can be a quick and relatively inexpensive method for startup companies to raise money from angel investors and early stage venture funds.
Convertible debt is an investment that can “convert” into equity in the future at the option of the debt holder, usually at a discount to the next funding round price, and which sometimes has a “cap” (maximum price). It is a low cost alternative to an equity investment, often issued before the Series A round. Early stage investors (e.g. angel, seed) take the most risk, and convertible notes, with or without a valuation cap, are structured to provided beneficial features to reward them.
At the same time, a convertible note protects the founders’ control over the company, and kicks valuation questions down the road until the Series A round. Still, for the young entrepreneur seeking financing, there are plenty of pitfalls (liquidation preferences, interest rates, taxation, etc.).
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