MyStartupEquity
  • Homepage
  • ESOP
    • ESOP for Founders
    • ESOP for Employees
  • Cap Table
  • Webinars
  • News
  • Open Source Docs
Likes
Followers
  • MyStartupEquity
  • Contact Us
MyStartupEquity Blog

Digitize your equity stack

MyStartupEquity
  • Homepage
  • ESOP
    • ESOP for Founders
    • ESOP for Employees
  • Cap Table
  • Webinars
  • News
  • Open Source Docs
  • Captable

What is a Convertible Note (CN)? How to use it?

  • January 6, 2021
  • Roshan Raj

Convertible Note is an investment vehicle issued by startups. In the very simplest of terms, a convertible note (CN) can be thought of as such – an investor gives money to a startup in its first round of funding and instead of acquiring shares upfront, he takes convertible shares, which can either be cashed out or converted to equity at a later date (basis some pre-agreed upon terms). Typically, CNs are issued when the valuation of the startup at the very early stages has not been established.

In India as per the latest legislation, convertible notes can only be issued when: 

  1. The investment amount is more than or equal to INR 25 lakh
  2. The startup is DPIIT (Department for Promotion of Industry and Internal Trade) approved

To understand convertible notes better, let’s consider this simple example. 

Anirudh Sharma is an angel investor ready to invest INR 25 lakh in a seed-stage startup called Waky in July 2020. However, Waky is still very early and it’s becoming difficult to arrive at a valuation for the company; thus they cannot offer equity upfront to Anirudh.  Instead, the two parties mutually decide to explore convertible notes. They decide that convertible notes worth INR 25 lakh will convert to equity shares with a 20% discount at Series A valuation. This means Anirudh will get a 20% discount on the price of each share at the time of conversion. In the worst case if there is no round within the next 18 months, then the convertible note will mandatorily get converted at a predefined base valuation.

Fast forward to July 2021, Waky has done well, raised INR 2 cr and its shares are now worth INR 10,000 each. Anirudh’s CNs will now convert along with the round and he will receive shares at a 20% discount to ₹10,000, i.e. ₹8000 per share, so he will get ₹2500000/₹8000 = 313 shares in Waky. 

Why is this a win for Anirudh? 

  • As an early investor, he was able to negotiate a good discount and therefore earned 313 shares of the company instead of 250 shares that he would have received at the round share price of ₹10000 (₹2500000/₹10000 = 250)
  • If Waky had not succeeded and went south, Anuridh’s convertible note  would have been settled before settling dues of ‘equity’ shareholders 

Why is this a win for Waky? 

  • The startup didn’t have to use up cash to return Anirudh’s investment. Instead, they issued him equity shares pretty much like any equity-based investment into the startup.
  • Therefore, startups leverage convertible notes in early stages (where valuation can’t be determined) or during bridge rounds (where valuation is better deferred to a later date when the bigger VC round happens).

You might be wondering about the difference between convertible notes and CCDs. The key difference is that startups don’t require a valuation certificate to issue convertible notes.


Click here for our complete and comprehensive ESOP dictionary
Click here to know efficient ways for cap table management

Total
0
Shares
Tweet 0
Share 0
Share 0
Related Topics
  • cap table
  • CN
  • Convertible Note
  • indian startup ecosystem
  • indian startup investment
  • Indian Startups
  • investment vehicles
  • investments
  • investors
  • startup
  • startups in india
Roshan Raj

Previous Article
RSUs - Restricted stock units
  • Captable

What are RSUs – Restricted Stock Units?

  • December 28, 2020
  • Roshan Raj
Read More
Next Article
Harpreet Singh Grover - Managing Talent
  • ESOP
  • ESOP for Founders

Managing Talent | Harpreet Singh Grover

  • January 17, 2021
  • Roshan Raj
Read More
You May Also Like
RSUs - Restricted stock units
Read More
  • Captable

What are RSUs – Restricted Stock Units?

  • Roshan Raj
  • December 28, 2020
Read More
  • Captable

Convert securities at the click of a button

  • Roshan Raj
  • December 11, 2020
Read More
  • Captable

What is Scenario Modeling?

  • Roshan Raj
  • December 11, 2020
Read More
  • Captable

How do I manage my Cap Table efficiently?

  • Roshan Raj
  • December 11, 2020
fully-diluted cap table
Read More
  • Captable

What is a fully-diluted cap table?

  • Roshan Raj
  • December 11, 2020
what are warrants
Read More
  • Captable

What are Warrants?

  • Roshan Raj
  • November 25, 2020
Scripbox Core Team - ESOP Management
Read More
  • Captable
  • ESOP
  • ESOP for Employees
  • ESOP for Founders

ESOP Management at Scripbox

  • Roshan Raj
  • November 2, 2020
Preference & equity shares
Read More
  • Captable

What is the difference between preference shares & equity shares?

  • Anshu Tiwari
  • August 17, 2020

Subscribe to our Newsletter

* indicates required
Featured Posts
  • Harpreet Singh Grover - Managing Talent 1
    Managing Talent | Harpreet Singh Grover
    • January 17, 2021
  • Convertible Note 2
    What is a Convertible Note (CN)? How to use it?
    • January 6, 2021
  • RSUs - Restricted stock units 3
    What are RSUs – Restricted Stock Units?
    • December 28, 2020
  • 4
    #LetsTalkEquity | The ‘fearless’ CFO and his ‘do it’ attitude
    • December 17, 2020
  • 5
    Convert securities at the click of a button
    • December 11, 2020
Recent Posts
  • What is Scenario Modeling?
    • December 11, 2020
  • How do I manage my Cap Table efficiently?
    • December 11, 2020
  • fully-diluted cap table
    What is a fully-diluted cap table?
    • December 11, 2020
Categories
  • Captable (12)
  • ESOP (9)
  • ESOP for Employees (19)
  • ESOP for Founders (36)
  • News (25)
  • Webinars (7)
MyStartupEquity Blog
  • MyStartupEquity
  • Contact Us
Digitize your equity stack

Input your search keywords and press Enter.