Raising money is vital for every small business owner. As an entrepreneur, you have a few potential sources available. These traditionally include bank loans or investments from angel investors or venture capitalists in exchange for equity in your company. A bank loan can help you get money, and an equity investment from an angel or venture capitalist also provides you with professional business advice from someone who has done this many times before, in exchange for a percentage of ownership to the investor.
If you’re concerned about giving up part of your company, you have another option available. Another way to raise money from professional investors without initially giving up equity is a convertible note. A convertible note starts out as debt (think of it as a loan or a bond), but it can be converted to equity on a predetermined date. You get money you need upfront. If you pay the note back completely before one of the conversion dates, you never have to give up equity in your company.
Convertible notes are usually used in situations where the startup involves high risk with the potential of high reward. Typically, a low-risk company will not pursue convertible notes for funding purposes. Some of the main advantages of a convertible note include a simplified funding structure and potential tax benefits over equity. One of the potential disadvantages is a possible loss of voting control if the note is converted down the road. There is also a cash-flow risk that increases as the maturity of the convertible note decreases.
Overall, convertible notes are an interesting way to raise funds from professional investors. They start out as debt and can convert to equity later in the note’s life. This mix of debt and equity characteristics may be perfect for your business’ funding needs.