There are pros and cons to using a convertible note.
Startups use them primarily for seed rounds and bridge rounds.
They are lower in cost, as the documents are simpler than equity terms sheets.
They avoid setting a price, so they are easier to negotiate.
It keeps the cap table simple as they start in debt form and convert to equity later.
The downside is that they have few protective provisions found in equity terms sheets, such as board seats.
Valuation is not fixed. A later-priced round will set it and there’s little control the investor has over it.
There are no tax benefits for a Qualified Small Business 1202, which applies only to equity investments.
In summary, a convertible note is useful for launching a seed fundraise or even a Series A, as it lets the startup capture interest into the deal while searching for the lead investor.
An equity round should be done to set the valuation and provide tax benefits and protective provisions for the investor.
Thank you for joining us for the Startup Funding Espresso where we help startups and investors connect for funding.
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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.