► Convertible Note Term Sheet Template
► Template Features and Key Provisions
- Professionally prepared by experienced corporate/securities lawyers trained at large law firms
- MS Word Format / Fully Customizable
- Legal grade quality for use with all types of financing/investment transactions
- Instant download
- See a Sample Page Here
► What is Included
Are you an entrepreneur looking for a simple and efficient way to raise capital for your startup? Our Convertible Note Term Sheet template can help. In this article, we’ll explore what our template includes and provide essential information about convertible notes. Our Convertible Note Term Sheet template provides sample terms to guide you through the fundraising process. With your purchase, you will receive:
- Convertible Note Term Sheet : A professionally drafted document that outlines the terms and conditions of the convertible note, ensuring legal compliance and protecting the rights of all parties.
- Template Form: Outlining the conversion mechanics, including the conversion price, discount rate, and valuation cap, allowing you to customize the terms to your needs.
- Sample Clauses: Common clauses to address different scenarios and protect the interests of investors and entrepreneurs, saving you time in drafting.
► What is a Convertible Note ?
A convertible note is a versatile financing instrument widely used by startups to secure early-stage investments. It combines elements of debt and equity, offering an efficient way to raise capital while deferring the determination of the company’s valuation until a future financing event. A convertible note represents a loan from investors that has the potential to convert into equity under predetermined conditions, typically triggered by a subsequent funding round or a specific milestone achievement.
► How Does a Convertible Note Work?
When you issue a convertible note, investors provide funds to your company with the understanding that the debt will convert into equity at a later stage. The conversion usually takes place during a qualifying financing round or upon reaching specific predetermined milestones. The terms of the note, including the conversion price, discount rate, valuation cap, and other provisions, play a crucial role in determining the conversion ratio and the number of shares the investor will receive upon conversion.
The conversion price represents the price per share at which the note converts into equity. It is typically determined by applying a discount rate or referencing a valuation cap. The discount rate provides investors with a predetermined percentage reduction from the price per share paid by future investors in the subsequent financing round, enabling them to enjoy a potential financial advantage. On the other hand, the valuation cap serves as a maximum valuation at which the note
► Who Can Use Convertible Notes?
Convertible notes offer a flexible and straightforward financing option suitable for a wide range of startups across various industries. Whether you operate in technology, biotechnology, consumer goods, or other sectors, convertible notes provide benefits for both entrepreneurs and investors. They are particularly attractive to early-stage investors who prioritize supporting promising ideas and startups while minimizing the complexities and negotiations often associated with equity financing. As an entrepreneur, utilizing convertible notes allows you to quickly raise capital, maintain flexibility in your early-stage valuation, and focus on driving the growth of your startup.
► What are the Key Terms for Convertible Notes?
Understanding the key terms associated with convertible notes is essential for crafting a fair and mutually beneficial agreement. Here are some key terms commonly encountered in convertible note arrangements:
- Conversion Price: The conversion price is the price per share at which the convertible note converts into equity. It can be determined through various methods, such as applying a discount rate or referencing a valuation cap. The conversion price directly impacts the number of shares the investor will receive upon conversion.
- Discount Rate: The discount rate is a predetermined percentage reduction applied to the price per share upon conversion. It offers investors a discount compared to the price paid by future investors in the subsequent financing round. The discount rate rewards early investors for taking on the higher risk associated with investing at an early stage.
- Valuation Cap: The valuation cap represents the maximum valuation at which the convertible note will convert into equity. It serves to protect early investors from dilution in the event that the company achieves a high valuation in subsequent funding rounds. The valuation cap ensures that early investors are not unfairly disadvantaged due to the increased value of the company.
► What are the Benefits of using Convertible Notes?
When it comes to raising capital for your startup, convertible notes have gained popularity as a financing instrument. They offer a unique blend of debt and equity characteristics, providing benefits for both entrepreneurs and investors. However, like any financial tool, convertible notes come with their own set of advantages and disadvantages. In this article, we will explore the pros and cons of convertible notes to help you make an informed decision when considering this fundraising option.
Advantages of Convertible Notes:
- Quick and Efficient Fundraising: One of the significant advantages of convertible notes is their ability to facilitate swift fundraising. Compared to equity financing, which involves complex valuation negotiations, convertible notes offer a simpler and faster process. Entrepreneurs can secure funding without the need to determine the startup’s valuation at the early stages. This speed and efficiency enable startups to focus on their core operations and accelerate their growth trajectory.
- Deferred Valuation: Convertible notes allow startups to defer the valuation process until a later stage, typically during a subsequent funding round. By postponing valuation discussions, entrepreneurs can focus on building their business and achieving key milestones before assigning a value to their startup. This flexibility can be advantageous when the company’s worth is uncertain or difficult to assess early on.
- Investor-Friendly Terms: Convertible notes often come with terms that are favorable to early-stage investors. For example, they may include a discount rate, which provides investors with a predetermined percentage reduction when converting their debt into equity. Additionally, convertible notes may feature a valuation cap, which establishes a maximum valuation at which the note converts, protecting investors from excessive dilution. These investor-friendly terms make convertible notes an attractive option for early-stage investors who are willing to take on higher risks.
- Minimal Governance and Investor Rights: Compared to equity financing, convertible notes typically involve fewer governance requirements and investor rights. Startups can avoid complex shareholder agreements and maintain more control over decision-making. This flexibility can be beneficial for entrepreneurs who want to retain autonomy and agile decision-making processes during the early stages of their startup’s growth.
► What are the Disadvatnages of using Convertible Notes?
- Debt Obligation: Convertible notes are essentially debt instruments that require repayment at maturity if the conversion does not occur. If the startup fails to secure subsequent funding or reach the predetermined milestones, the debt may become due, creating a potential financial burden. This debt obligation can put additional pressure on startups, especially if they face challenges in raising capital or achieving growth targets.
- Dilution of Ownership: Upon conversion, convertible notes can result in dilution of the ownership stake held by the entrepreneur and existing shareholders. As new equity is issued to the noteholders, the overall ownership percentage of the original shareholders may decrease. While dilution is a common aspect of equity financing, it is important for entrepreneurs to carefully consider the impact of potential dilution when utilizing convertible notes.
- Uncertain Conversion Terms: The conversion terms of a convertible note can introduce uncertainty for both the entrepreneur and the investor. Factors such as the conversion price, discount rate, and valuation cap can significantly impact the final conversion outcome. The entrepreneur may be concerned about potential dilution if the conversion occurs at an unfavorable price, while investors may be cautious about not achieving the desired return on their investment. Clear communication and negotiation of these terms are essential to ensure a fair and mutually beneficial agreement.
- Limited Investor Influence: Convertible note investors typically have minimal governance rights and influence compared to equity investors. They may lack voting rights and the ability to actively participate in major decision-making processes. This limited investor influence can be a disadvantage for those investors seeking an active role in shaping the company’s direction and strategy.