The Essential Guide to Convertible Notes in Cap Tables

The Essential Guide to Convertible Notes in Cap Tables

When it comes to raising capital for your startup, there are many financing options available. One of the most popular methods is using convertible notes. A convertible note is a type of debt that can convert into equity. In this guide, we’ll explain everything you need to know about convertible notes in cap tables.

What is a Convertible Note?

A convertible note is a type of debt that can convert into equity. Essentially, investors loan money to your company with the expectation that it will be paid back or converted into ownership in the future. Convertible notes are often used in early-stage financings because they are simple, flexible, and can delay the valuation negotiation until later rounds.

How Does a Convertible Note Convert to Equity?

Convertible notes convert to equity when a trigger event takes place. This event can be a new funding round, an IPO, or a buyout. When the trigger event occurs, the investor’s debt converts into equity at a predetermined price per share. The conversion price is usually defined in the terms of the note.

How Are Convertible Notes Reflected in Cap Tables?

Cap tables are tables that show who owns equity in your company, how much they own, and what type of equity they own. Convertible notes are reflected in cap tables as both debt and equity. Initially, the convertible note will be listed as debt. However, once the conversion event occurs, the debt will be converted into equity and reflected in the cap table as such.

How Does the Conversion Price Affect Cap Tables?

The conversion price of a convertible note can have a significant impact on the cap table. A lower conversion price results in a higher number of shares issued, diluting the value of existing shares. On the other hand, a higher conversion price results in a lower number of shares issued, increasing the value of existing shares.

What Are the Benefits of Using Convertible Notes in Cap Tables?

There are several benefits to using convertible notes in cap tables, including:

  • Simplicity: Convertible notes are simpler than equity offerings because there is no need to determine the valuation of the company at the time of investment.
  • Delayed Valuation: Convertible notes delay the valuation negotiation to a later round when it may be easier to determine the true value of the company.
  • Flexibility: Convertible notes can be structured in various ways to meet the needs of both the company and investors.

Conclusion

Convertible notes are a popular financing option for startups looking to raise capital. They are flexible, simple, and can delay the valuation negotiation until later rounds. When using convertible notes in cap tables, it’s important to understand how they convert to equity, how the conversion price affects the cap table, and the benefits of using them. With this knowledge, you’ll be better equipped to make informed decisions about financing your startup.