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What Is a Convertible Note and How Does It Work?

Countless businesses, especially startups, use convertible notes to finance their operations. It’s a unique form of financing that’s beneficial to both businesses and investors. With a convertible note, businesses can obtain money from an investor, whereas the investor will receive ownership in the business at a late time. What is a convertible note exactly?

What Is a Convertible Note and How Does It Work?

Overview of Convertible Notes

A convertible note is a form of financing in which an investor loans money to a business under the agreement that some or all of the debt may be repaid in the form of stock shares in the future.

Startups often use convertible notes to secure financing. Startups don’t have a proven track record, so they are considered risky for banks. If a startup can’t obtain a loan from a bank, it may seek financing by offering a convertible note.

How Convertible Notes Work

Convertible notes are similar to traditional loans, except they give investors the option of converting the debt into equity. Conversion notes come with guidelines set forth in the conversion privileges. These conversion privileges specify what investors can and can’t do with the convertible note.

Most convertible notes require businesses to pay a fixed interest rate until a specified date. This, of course, is similar to bank loans. With both bank loans and convertible notes, businesses that receive financing must pay interest. The difference is that convertible notes automatically “convert” the business’s outstanding debt into equity.

The Benefits of Convertible Notes

Convertible notes offer several benefits. It’s a fast and relatively easy way to secure financing. With a convertible note, you won’t have the jump through the otherwise confusing hoops of applying for a bank loan. You can pitch your business to an investor, and if he or she thinks it’s a good idea, the investor may agree to a convertible note.

You won’t have to repay the debt of a convertible note. When a convertible note matures, it will automatically convert into stock shares. Therefore, the investor will receive stock shares in your business, which essentially erases the debt.

Convertible notes aren’t suitable for all businesses. If your business is still in its early stages, though, you may want to consider it. With a convertible note, you can receive financing in exchange for stock shares. You’ll receive money from the investor almost immediately, but the investor won’t receive the stock shares until the convertible note matures.

This article was brought to you by Intrepid Private Capital Group – A Global Financial Services Company. For more information on startup and business funding, or to complete a funding application, please visit our website.

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Intrepid Private Capital Group • November 19, 2020

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