CONVERTIBLE NOTE

A Convertible Note is a short-term unsecured debt instrument that will convert into equity upon the occurrence of a triggering event. For example, when the convertible note is used as a seed financing13, the triggering event is usually the closing of a series A 14 equity round of financing. The underlying idea is that the investor receives shares 15 of the company and dividend payments in lieu of principal and interest payments. After the triggering event, the investor is entitled to convert at the lower of (i) the price of the financing round (after applying a discount rate, if any) and (ii) the valuation cap (if any).

Purpose/Fit

Flexible, quick and simple source of funding in unpriced 16 seed rounds

Can replace

Equity, SAFE, debt – conventional loan

Risk/Return Profile

High Risk/High Return

Enterprise Lifecyle

Seed stage

Maturity

It depends on the maturity date defined ex ante

Defining Criteria

Triggering event:

It is usually an equity funding round.

Discount rate:

It allows the investor to convert to equity at a discount price during a later round of financing. Discount rates typically range between 10% to 25%, and the discount factor is calculated as follows: [100 – discount rate]%

Valuation Cap:

Upon raising funds above a certain threshold, it allows the investor to convert at the cap share price. The valuation cap works as a ceiling on the valuation that will be used to calculate the conversion price for the convertible note investors, which are entitled to convert at the lower of the valuation cap or the price, in the subsequent financing.

Interes rate:

The convertible note is a hybrid debt instrument, and as such it has an interest rate. Unlike a traditional loan, however, the interest is typically not paid until maturity date. Furthermore, in the majority of the cases the interest coverts into equity instead of being paid in cash.

Maturity date:

Once the maturity date is reached, and no conversion has happened, then the company must pay back the principal and the interests accrued or convert into equity.

Interesting Variants and Options

The triggering event could be linked to a change of control, an M&A, or other predefined circumstances

In the case of a Convertible Note with Revenue Share Agreement, the schedule payment of the interest could be linked to a revenue share agreement.

Linking financial rewards to the achievement of impact, for example reducing the discount rate or increasing the valuation cap – see “Examples of relevant terms” below.

Purpose/Fit

Can replace

Risk/Return Profile

Enterprise Lifecyle

Maturity

Defining Criteria

Interesting Variants and Options

Source: Innovative Financing Toolkit, BRIDDHI, 2020

Other instruments that may be useful to you

REIMBURSABLE AND CONVERTIBLE SIINC

IMPACT-LINKED LOAN

IRMF (IMPACT-READY MATCHING FUND)

SIINC (SOCIAL IMPACT INCENTIVES)

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