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May 13, 2012 02:00 pm GMT
What Is a Conversion Discount? In the context of a seed financing, a convertible note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. A conversion discount (or discount) is a mechanism to reward the noteholders for their investment risk by granting to them the right to convert the amount of the loan, plus interest, at a reduced price (in percentage terms) to the purchase price paid by the Series A investors.In other words, the founders are saying to the investors, in effect, if you take this risk and give us money today, well reward you by giving you 20% off at our Series A round down the road (20% being the usual discount, as discussed below). For example, if the investors in a $500,000 convertible note seed financing were granted a discount of 20%, and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price (referred to as the conversion price) of $0.80 per share and thus receive 625,000 shares ($500,000 divided by $0.80), which is 125,000 shares more than a Series A investor would receive for its $500,000 investment and a 1.25x return on paper ($625,000 divided by $500,000). (The foregoing example does not include accrued interest on the loan, which is typically about 5%-7% annually, as discussed below.)
Original Link: http://feedproxy.google.com/~r/Techcrunch/~3/pBW10nPjSZo/
Convertible Note Seed Financings: Econ 101 For Founders
What Is a Conversion Discount? In the context of a seed financing, a convertible note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. A conversion discount (or discount) is a mechanism to reward the noteholders for their investment risk by granting to them the right to convert the amount of the loan, plus interest, at a reduced price (in percentage terms) to the purchase price paid by the Series A investors.In other words, the founders are saying to the investors, in effect, if you take this risk and give us money today, well reward you by giving you 20% off at our Series A round down the road (20% being the usual discount, as discussed below). For example, if the investors in a $500,000 convertible note seed financing were granted a discount of 20%, and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price (referred to as the conversion price) of $0.80 per share and thus receive 625,000 shares ($500,000 divided by $0.80), which is 125,000 shares more than a Series A investor would receive for its $500,000 investment and a 1.25x return on paper ($625,000 divided by $500,000). (The foregoing example does not include accrued interest on the loan, which is typically about 5%-7% annually, as discussed below.)Original Link: http://feedproxy.google.com/~r/Techcrunch/~3/pBW10nPjSZo/
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