A convertible note, also known as a convertible debt or convertible bond, is a type of debt instrument that can be converted into equity at a later date. This means that the holder of the convertible note has the option to exchange the note for a specified number of shares of the issuer’s common stock at a pre-determined conversion price.
Convertible notes are typically issued by startups and early-stage companies that need to raise capital but want to delay the valuation of their company until a later date. The issuance of convertible notes allows companies to raise money now, while avoiding the burden and expense of pricing their equity.
The terms of a convertible note typically include the following:
- Principal amount: The amount of money that the issuer is raising through the sale of the note.
- Interest rate: The rate at which interest will accrue on the outstanding principal amount of the note.
- Maturity date: The date on which the outstanding principal amount of the note must be repaid.
- Conversion price: The price per share at which the note can be converted into equity.
- Conversion ratio: The number of shares of common stock that will be issued for each $1 of principal amount converted.
Convertible notes can be attractive to investors because they offer the potential for upside in the form of equity in the company, while also providing downside protection in the form of a fixed interest rate. However, the value of a convertible note depends on the future performance of the underlying stock, and if the stock price doesn’t increase, the value of the note to the investor can decrease.
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