Do you need funds for your new or growing business? Do you have an innovative idea, but you are pre-revenue, so no ability to repay a debt? What would you like to do with the funds? How will you use them for your business? Can you sell your idea to an investor?

We’re often asked for help with financing a business. We suggest five key paths as follows:

  1. Loans;
  2. Grants;
  3. Convertible Notes;
  4. Equity funding; and
  5. Crowdfunding.

This article is one of a 5-part series on how to finance your business. This article focuses on convertible notes.

Convertible Notes

A convertible note is a promissory note or a written promise that is issued to your investors. The investors provide you with capital, and in return they receive a certain number of shares once a trigger event occurs. This can be when your business raises a certain amount of money, at which point the investor receives the agreed amount of shares at a discounted rate.

The main advantages are:

  • Using a convertible note means you can delay valuing your business and your shares until your company is more established. This is a significant advantage, as businesses can be hard to value at the start, and will typically have a low value.
  • You are not issuing equity too early, which helps you to maintain your control of the company. It is also often easier, cheaper and faster to issue a convertible note rather than go through the legal and practical hoops for an issue of shares. 

The main disadvantage is that it can be difficult to get investors interested in taking a convertible note instead of shares, as they may have more rights as a shareholder and are generally keen to maximise their equity.

One way to counter this is by including a ‘valuation cap’ that sets a maximum value for the company that will be used when the note is triggered. This effectively means that if your business is valued higher than the valuation cap, i.e. the investors will receive more shares for a cheaper price. However, this could be more detrimental to your company than if you had originally issued shares in the first place.

Conclusion

Is a convertible note right for you? It may be an excellent option to bring in investors without giving away equity. The terms of the convertible note are imperative. You will benefit from the advice in putting your proposal together and negotiating your convertible note agreement. LegalVision can help create or review your convertible note, so you fully understand the terms and are in as strong a position as possible.

Can LegalVision assist you with your convertible note? LegalVision provides businesses and individuals with tailored online legal advice, including drafting legal agreements like convertible notes. We have experienced finance lawyers who will help protect you. Call LegalVision on 1300 544 755.

Ursula Hogben

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