Convertible Note Terms: How Convertible Notes Work

[@SaadKhan-wk5ck]

this is the only video on youtube that explains it well

[@Startupsos]

Thanks!

[@Fitician]

Excellent video! One of the best and easiest to understand content on convertible notes. Thank you!

[@Startupsos]

Thanks!

[@vasantharajum9368]

One of the best explanations....thanks chief

[@jaesonbang5710]

This is probably the best explantion ever. Thank you

[@Startupsos]

Glad it was helpful!

[@davidschaefer4312]

Steve, excellent presentation! Thanks....

[@Startupsos]

Thanks David

[@RonDavisceo]

The best i have heard thanks sir

[@sswat38]

This video was absolutely brilliant. Please make more on other kinds of term sheets!!!

[@christasacco416]

Thank you. This was so helpful! 💡

[@billiebillie678]

This is great, Steve! Your explanation is very concise and easy to understand. You have explained this better than anyone who has explained it to me. Thank you so much!!

[@Startupsos]

Thanks!

[@vaasuji]

very well explained

[@canmind]

Best explanation of convertible note investments I have seen yet. Thank you Steve!

[@forbersimon3660]

Excellent, very clear.

[@jeremyhoskin7746]

Great explanation

[@1Root_]

Whooh , just amazing explaination !🤩 Crystal clear & to the point ! Subscribed 🥂

[@78rakeshmahato]

you are fabulous sir and it is very clear that your experiences are truly helping many. I have been using almost all of these terms. Thank you for making us understand with your super simple example.🙏

[@Frank-pg7xx]

Thank you! Very digestible and clear to understand.

[@Startupsos]

Thanks Frank

[@youngtaekim7068]

Great information and clear explanation!

[@KrispyAzza]

You are a great teacher, thank you for your breakdown and the series of steps you used to explain.

[@joaq9790]

Super Helpful! Namaste !

[@Startupsos]

Thanks!

[@farrukhbhatti8246]

Thanks Steve - concise and easy to understand.

[@a45williams]

You are awesome teacher, I learned a lot. I have to watch this video a couple of times because it's so compact of information.

[@PeterLigeti]

Excellent

[@deogratiasusa3160]

Thanks for the explanation! It was very helpful!

[@yasirwahid]

Thank you for this !

[@Startupsos]

My pleasure!

[@harshitaanand2058]

Than you so so much for this amazing video....Now I can crush everyone with my presentation!!!

[@Startupsos]

Best of luck!

[@Gamumee]

Did you crush it ?

[@harshitaanand2058]

@@Gamumee Lol...I think I used a lil too much of technical jargon...so I guess they didn't like it... But I'm happy I quoted all the important points while the others didn't even have a revenue model

[@georgyishak8760]

Thank you , this is so clear and helpful !

[@pofulover]

THANK YOU!!!!!!!!!!!!!!! OMG YOU EXPLAINED IT IN A WAY I UNDERSTOOD!!!!!!!!!

[@Startupsos]

Glad it helped!

[@AlexWinkler]

Notepad filled up. Great video!

[@dimonbonbon]

thanks

[@saimeatakan8539]

Awesome information Thank you so much!

[@Startupsos]

Glad it was helpful!

[@marco_solo]

Very helpful

[@FrankSalas]

Amazingly helpful. Thank you.

[@Startupsos]

Glad it was helpful!

[@bolsademanerafacil2477]

Thank you!!! You explain very good!!!

[@Startupsos]

You're welcome!

[@SholaSalako]

You are awesome, Steve!

[@Startupsos]

Thanks!

[@jackbean9355]

Very informative! Thank you

[@DameonRussell]

Steve, excellent info. What if the convertible note is used for "friends & family" round at the Manager LLC level and we wish to have their interest convert to stock in the Investment Co. LLC where the equity is being raised via Limited Partners, (like a Reg D 506(c) Fund)?? Can a convertible note offered at one entity level be converted to stock in a subsidiary entity level?

[@Startupsos]

The most common arrangement I've seen is for the investors to put their money into an LLC (a fund) and the fund issues a convertible note to the startup receiving the investment. So it's the LLC making the investment. Assuming the 506(c) exemption is used, all the investors in the fund need to self-certify that they are accredited investors, and the LLC (fund) agreement would specify exactly what happens when there is an exit (i.e., typically the proceeds are distributed to the investors in the fund on a pro-rata basis).

[@GeneralEG]

Thank you steve for the great efforts!!

[@Startupsos]

My pleasure!

[@danielarodarte2270]

Thank you! Very clear to understand!!

[@Startupsos]

Thanks!

[@voorhees3982]

Really helpful. Thank you

[@Startupsos]

You're welcome!

[@mikeb6354]

that was fantastic

[@wl4131]

Thank you

[@dennismutunga4486]

Thank you Steve.

[@Startupsos]

Thanks for watching!

[@ThysWind]

Super helpful - thank you! Curious to know what kind of attorney I would need to help me with this.

[@Startupsos]

I'd suggest an "emerging business" attorney who works with startups and is familiar with the SEC regulations that relate to startup-relevant SEC exemptions.

[@ThysWind]

@@Startupsos thank you!

[@lordmonaco]

Hey there Steve! Quick Q - how common is the option pool? Is this at the discretion of the founder? What is the real benefit, if so?

[@Startupsos]

Option pools are very common because they are a convenient way to provide equity compensation to employees, advisors, independent directors on the Board of Directors and even to contractors and vendors. Unlike granting actual stock, options have the advantage that there is typically no tax impact when they are granted - only when they are exercised. They also have the advantage that they can vest over time, or they can vest based on reaching specific milestones. In an investment round, it's very common for investors to insist that the company allocate additional shares for the option pool because presumably you'll be hiring people with the proceeds of the round, and you'll likely be awarding options so you need a bigger pool. Investors usually want those options to be allocated prior to them investing, so the founders absorb the dilution, not the investors.

[@noelc1007]

I love these videos, very helpful and informative ..... however ... could you provide some info on how as a startup you should calculate your CAP for a Convertible Note ? I understand the discount and interest rate and when and how they are converted etc. .... but I can't find any description on how you come up with your CAP figure.

[@Startupsos]

Sounds like a good topic for my next video! The short answer: investors like a lower cap because the lower the cap the more of your company they get (assuming the cap is below the pre-value money of the priced round). In a perfect world, you'd set the cap to be equal to the pre-money value of the priced round that converts the Note, because that would minimize your dilution. The challenge is - you don't have a perfect crystal ball in which to see just what the future pre-money value will be - but you can make your best guess and negotiate from there.

[@noelc1007]

@@Startupsos thank you for your reply, yes a video on that would be helpful ...... if you could include a guide at least for placing a value of some sort on Patents. We are a start up with Patents ..... we are about to do our first funding with an Angel 🤞. The figure we choose for our CAP is literally a wet finger in the air !!!

[@davetheman2615]

brilliant thanks

[@Startupsos]

Glad it helped

[@NemoBusy]

To the point! Thank You.

[@Startupsos]

Thanks!

[@ethanchabert]

Great video and information! Thanks!

[@Startupsos]

Thanks for watching!

[@REInvestorCEO]

Thank you!

[@Startupsos]

You're welcome!

[@Essays4College]

Great video! Very informative. I wish you could have touched on the tax impact a bit more though. Why could the company not be an S-Corp instead of a C-Corp? Wouldn't the S-Corp avoid the double taxation?

[@Startupsos]

It's OK to be an S-Corp or a C-Corp or LLC when you receive a convertible note (because it is just a loan) but the note converts to stock in a priced round, and in a price round, most investors who invest in growth companies do not want to invest in a pass-through entity like an LLC or an S-Corp, because if the company makes a profit, that income passes through to the investors and causes a tax liability. So priced rounds in growth startups generally invest in C-corps, and it's a very common term in a convertible note to require that the company convert to a C-corp when the note converts to stock. It all has to do with taxes.

[@gabrieldineros587]

What about the 8% interest you mentioned?

[@Nyax02]

Amazing presentation Steve, how do i get a chance to have a one on one to ask a few specific questions to a project i am working on?

[@Startupsos]

Sorry for the delay - but if you still have questions, please email me: startupsos at gmail dot com

[@inloveofmusic]

Hi Steve, Is it accurate to say that after conversion into common stock, the convertible note holders get paid their pro-rata equity percentage after preferred shareholders are paid? If conversion results into 15% equity on fully diluted basis. Do the conversion note holders now holding common stock get paid 15% of balance after preferred share holders are paid? Do convertible notes have liquidation preference?

[@Startupsos]

When the convertible note converts to stock, it converts on the same terms as the stock that goes to the investors who invest in the priced round that triggered the conversion of the notes (except that note holders pay less per share if their note has a discount). Assuming the priced round is investing in preferred shares, the convertible note holders get the same type of preferred shares as the other investors in the round, including any liquidation rights. They have rights that are identical to the other preferred shareholders. Nobody actually gets paid any dollars until there is a later exit event - which usually would be an acquisition. In that case the investors that had been note holders are no different than the new investors in the priced round - they are all holders of the same type of stock and are all treated the same in terms of liquidation rights.

[@tajirreynolds2454]

he should write a book because he explains it the easiest way

[@fredichshain7441]

When it comes to interest, is the interest a fixed interest term or variable?

[@Startupsos]

Convertible notes I've seen have always had a fixed interest rate - but it would certainly be possible to have a variable rate. Having said that, I don't think it would be worth the added complexity to make it worthwhile for an investor to have a variable rate.

[@fredichshain7441]

@@Startupsos Thanks! And what is the common interest rate range?

[@sandeshbhandare7238]

I get it. Nice

[@Startupsos]

Excellent! Thanks

[@DylanKoch96]

The interest can also be paid out as coupons though?

[@Startupsos]

With a convertible note, you're typically not paying out the interest. Instead, it accrues, and is applied to the stock purchase when the note converts to stock.

[@DylanKoch96]

@@Startupsos Working directly with a convertible note issue in a company currently i can say this not what we are doing but i'm sure it is common

[@chadgtr34]

what is the filing required to issue $20 million of convertible notes?

[@Startupsos]

For any securities offering (and notes are securities) you would want to file for an exemption (see my video on SEC registration exemption). Reg D rule 506(b) is the most common exemption used, and is for an unlimited amount. I'd suggest talking to an emerging business attorney to see if that's the right fit for your situation.

[@vegetarianandsimple5388]

does a convertible note give me shares or must I buy shares at a discounted price

[@Startupsos]

A convertible note is just a loan - but a loan that is intended to convert to stock in the future when there is a priced round (a round where investors set a valuation and purchase stock in the company). An investor who invests via a convertible note receives stock at a discounted price (if the note had a discount) when there is a priced investment that triggers the conversion of the Note dollars to stock.

[@inflowsai8416]

difficult to be clearer

[@feranmiogundipe890]

does this mean that a convertible note is a debt investment?

[@Startupsos]

Initially, it is a debt - but the intent is that it will convert to stock when a priced-round triggers that conversion, and it becomes an equity investment.

[@XulTaiff]

Any one here after Nio's Offerings ?

[@gavinmellon9313]

Yep.

[@jafar5112]

Im here for Stem inc offering. Lol

[@Rays_Bad_Decisions]

What if you do not want to raise more money and your business is successful?

[@Startupsos]

Convertible notes are pursued with the goal of a future round - but that does not always happen. Written into the note there are usually 3 options if the end of the note term is reached with no conversion to stock: call the note, convert to ownership at a pre-determined valuation, or extend the note. If the company is doing well, but a future investment round or an acquisition is unlikely, then there is always the option of offering to pay the note-holders back with an attractive interest rate. For the right deal, the investors might be quite happy to accept such an arrangement, rather than call the note (and get very little return), or convert it to equity with little prospect of any return at all. If there is the possibility of an acquisition, then they might opt to extend the note, or convert to stock at whatever pre-money value is specified in the note.

[@gangstaboss2639]

this video is not good at all, the explanations are not detailed and most of them are confusing because he thinks that we are watching the video when we already have a bit of knowledge on convertible bonds, this video is very ambiguous and did not answer any of my questions

[@HandsOnRealEstate]

Thank you