By Tina Baker (Contributing Writer, Forbes) Early stage funding for startups is getting complicated. In the past several years, many companies have raised initial seed funding through convertible loans instead of selling shares. In this type of funding, the loan, together with interest, automatically converts into the shares a company sells in its next funding round at a discount (ranges are between 10% and 30%) and there may be specific limitations on the size of that funding.
The primary reasons for their popularity are that using the note structure postpones a valuation discussion and the paperwork may be less complicated (and thus less expensive), although I have worked on some convertible loan transactions which have looked more like a Series A round.
Convertible notes can be a good thing. If shares are issued to angel investors at too high a valuation, it potentially scares off further investment and the company can become “too expensive”. The thinking is, let’s leave it to Series A and let the bigger investors decide. In some cases this may work out fine, but there are some downsides to the entrepreneur.
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