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Difference in Convertible Notes and shares investment

Posted on 17 June 2014

If you own a startup, then you can choose investments by convertible notes or equity. As you might know, raising money is not an easy task, so you want to offer the best conditions to your potential investors. Let’s take a look at the differences between convertible notes and shares investment, and see what are the benefits and downsides.

 

Convertible Notes

If you’re starting a new business and have a hard time financing it, convertible notes may be an option. Also, it is often easier to find a lender for this method of financing, because of the low risks. Convertible notes have recently become a really popular financing instrument, and here’s a brief definition what convertible notes are and how they work.

Convertible notes basically represent a loan which can be converted into equity at a later date. You can also add caps to a convertible note, to set a limit for how much the business can grow before the shares stop getting diluted.

 

Equity

To use this investment method, the startup has to get a valuation to determine a share price. This way the investor knows exacly how many shares you will own.

 

Benefits of Convertible Notes

Here are a few reasons why convertible notes are becoming more and more popular, even if at first sight the equity is more transparent so much easier to undestand. In summary, the best thing about equity is that there is no repayment down the line and investors are given a clearer picture.

• Valuation

Convertible notes allow startups to get the necessary funds without setting a valuation before the investor or investors start financing the project, making them really atractive to new companies.

The valuation of a startup can be a difficult task, and especially if the startup is only in the idea phase, since you can’t really put a price on an ideea. Convertible notes give startups the possibility to dellay the actual pricing.

• Cost

Convertible notes are less expensive then equity, although the cost difference is starting to get smaller.

•  Speed

Convertible notes can be easier to negociate and the terms are simple, so they can be closed faster then the equity valuation for shares investment.

• Control

In a convertible debt agreement, investors are considered creditors of the business. This way, the founders of the startup still retain the majority of the voting stock, and have better controll over the business. In summary, Convertible Notes can be a great way to raise money if you are starting a new company because they are also attractive to potential investors.

Remember that every startup is diferent and since every situation is unique, there are no general rules that apply to all cases. As a startupfounder, remember to give your investors good terms because they are helping you accomplish your goals. If you are an investor, remember to keep the terms as simple as possible, to give the founders the oportunity to focus on growing the business and making a profit.

Tagged in: convertible debt agreement Convertible Notes creditors of the business. shares investment startup