
Now that we have considered the principal reasons a startup may choose to issue convertible notes to investors in lieu of selling shares – namely, to raise capital efficiently and without a fixed valuation – let’s get a better understanding of how a convertible note offering works. Because a startup investor’s strategy is fundamentally high-risk high-reward, convertible notes look much different than, for example, a traditional bank loan to a small business. The goal of a small business lender is to collect interest income whereas the goal of a convertible note investor is to acquire equity in a startup (at a discount) and eventually participate in a liquidity event in the form of a company sale or IPO. Therefore, the deal terms of a convertible note offering differ significantly from more traditional forms of debt financing and are more negotiable. For this reason, it is important for founders and investors to understand the typical deal terms when issuing or investing in a convertible note.
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