A Crowd Convertible Promissory Note (“Convertible Note”) is a type of debt security issued by a company to investors (“Holders”) that may be converted into equity at a later time.
At the maturity date or upon a qualified financing event (as defined by the terms of the Note), the Convertible Note may convert into equity at a predetermined conversion price or the principal plus interest of the Convertible Note must be repaid. Convertible Note interest may be accrued and converted to equity subject to the terms of the offering or paid out in cash.
Investors should carefully review the terms, conduct due diligence on the issuer, and understand the risks before considering an investment in a Convertible Note.
Convertible Note Terms:
- Conversion Terms: The conversion terms specify when and how the Convertible Note can be converted into equity, including the conversion price, conversion ratio, and conversion events.
- Interest Rate: The interest rate is the percentage that the investor will earn on the Convertible Note until it matures or is converted into equity.
- Maturity Date: The maturity date is the date that the Convertible Note must be repaid, either with interest or converted into equity.
- Valuation Cap: The valuation cap is the maximum valuation at which the Convertible Note can be converted into equity, protecting investors from excessive dilution if the company's value increases significantly.
- Discount Rate: The discount rate is the percentage discount that the investor may receive when converting the Convertible Note into equity, compared to the price paid by a later round of investors. Convertible Note holders may convert to equity based on the Discount or the Valuation Cap, whichever is in their benefit.
- Rights and Restrictions: The Convertible Note may include various rights and restrictions that affect the investor's ownership and control, such as voting rights, liquidation preferences, and anti-dilution provisions.
- Use of Proceeds: The company may specify how it plans to use the proceeds from the Convertible Note, which can provide insight into its business strategy and potential risks.
Convertible Note Risks:
- Risk of Default: If the company fails to repay the Convertible Note when it matures, investors risk losing their investment.
- Risk of Dilution: If the company performs well and issues more shares in the future, the conversion of the Convertible Note into equity may dilute the value of the investor's ownership stake.
- Risk of Illiquidity: Convertible Notes are not easily traded, which may make it difficult for investors to sell their investment if they need to.
- Risk of Insufficient Capital: If the company does not raise enough capital, it may not be able to execute its business plan successfully, which could result in a loss for the investor.