Convertible bonds: Combining the best of two worlds
These features are what change a vanilla loan into convertible debt. Like ordinary notes, convertible debt notes provide an issuance date, interest rate and maturity date. Unlike conventional loans, repayment is with equity. The discount rewards early investors for taking larger risks than later investors by offering them the right to obtain shares at a cheaper price than that paid by Series A investors, once the Series A round closes.
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The conversion cap also rewards early investors for their early risk, but in a different way than the discount. The cap sets the maximum value of a company when Series A closes, again giving an advantage to earlier investors.
The discount and cap offer early investors two different ways to value their original investment the loan when the Series A round closes with a specified valuation. One method will usually give the investor a higher rate of return than the other.
Download Valuation Of Convertible Bonds When Investors Act Strategically
The Note Gets Repaid at a Premium. This approach tends to align the interests of founders and investors. The premium can range anywhere from. This is the most favorable to founders since it requires only that the company repay the loan plus interest. However, sophisticated investors usually want to be rewarded for assuming high risk early on. However, if the acquisition price is too low, debt holders can be more inclined to demand repayment and reject any conversion option.
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