Recently, many Startups and Investors have started experimenting and Investing in Startups using Convertible Notes.
To begin with Convertible Notes are not new, they have been in existence since long and are frequently used for investments across geographies and investor groups. However in India, they have been getting main-stream recently !

So let’s understand,
1. What are Convertible Notes (CN’s)
2. What are general industry terms on CN’s
3. How does a CN work and what does the cap table look like post conversion
4. Are CN’s legal in India
5. Is CN right for your Startup

What are convertible Notes ?

  • CNs’ are instruments that allow a Company (including Startups) to raise capital without the discovery of valuation. Valuation of the Company is pushed to a future date when there is more information to value the Company.
  • CN’s are usually used an early stage in the Company’s lifecycle
  • A vanilla CN sounds like “Company proposes to raise INR 3,00,00,000 (USD 400,000) by issuing CN’s. The CN’s shall convert at future date or at the next Investment Round”
  • CN’s may carry discounts at the time of conversion , valuation caps or floors.

What are general industry terms on CN’s
Convertible Terms are hotly negotiated on the following parameters

  • % discount to the next round valuation : The % discount range between 10% to 35% for time-spans ranging from 6 months to 36 months. Lower the time to the next round, lower the % discount. (The reason being that the happening of a next round is an indication of lowered risk for the existing investor)
  • Valuation Cap and Floor : There may be caps and floors to the CN. The Cap says that the CN will convert at a fixed value (value of cap) in the event the value of the company goes beyond the cap. The Floor works inversely to the cap.

How does a CN work and what does the cap table look like post conversion
Let’s take a convertible note scenario :
>> Startup is raising INR 3,00,00,000 (USD 400,000) by issuing 30,000 CCPS shares at INR 1,000 per CCPS
>> The Convertible Note will convert at a 20% discount to next round valuation. Here’s what the cap table looks like

Cap Table Pre and Post Conversion (Assuming Scenario 1)

The convertible note will convert as under for the following scenarios. Do observe that higher the valuation lower the dilution for the Founders which is how the CN’s help.

CN under different scenarios

Are CN’s legal in India
Yes, CN’s in India are legal and can take the form of CCPS or CCD’s or simply Convertible Note. We’ll cover Tax and Regulatory aspects of Convertible Notes in our future posts

Is Convertible Note right for your Startup
There is no one solutions fits all approach to this. However, if your company is at an idea stage that needs capital on an immediate basis without detailed discussion on valuation, investor rights and dilution then a convertible note will serve your right.
Beware of steep discounts to next round though. As higher discounts to next round will result in greater dilution.

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