What are the pros and cons of having a convertible note instead of venture funding?

Convertible notes, like any other form of investment, has its ups and downs:

  • One of its biggest pros is the fact that it is easy to set-up. Because it is easier, it is usually faster and cheaper.
  • Convertible notes can provide several benefits for an investor. When a convertible note is being used, investor is usually taking quite a risk because they are thinking about investing their money in a business that doesn’t have a valuation. Valuation isn’t always easy to come by in a startup in its early stages, of course. One of the benefits for an investor is a valuation cap. This creates a max value for the company during future financing. So, noteholders are able to convert over to equity for a better price per share.

On the downside of the convertible note equation we have:

  • The fact that those shares may be worth more or less than you thought they would be. Of course, this may be good or bad. It would be bad for you if your investor ended up owning more of the company than you anticipated because the shares are extremely cheap. Of course, if the shares are worth more at the time it converts, you could end up happier!
  • Timing isn’t always optimal. Will your startup be ready within the next two years (or less) to take on the debt?

Although convertible notes are easier, make sure that it is the best option for your startup. Make sure that you understand what you’re signing before you sign it. I can’t emphasize that enough. If you have a startup (or you’re thinking about one), you should get an expert opinion on whether convertible notes are your best option.

LawTrades is a marketplace that was created in order to give startups an efficient and affordable legal resource. We make it easy for entrepreneurs and businesses to connect and work with vetted, high-quality attorneys. Our site offers things like transparent flat-fee pricing, complimentary consultations, a satisfaction guarantee and start-to-finish project management. We also have another service – LawTrades Micro. This gives you the opportunity to ask an experienced attorney a question (such as whether convertible notes are your best option) for a low fee (usually just $25). You’ll get a customized answer within 48 hours. Hope this helps and g’luck!