A convertible bond provides the company with an interest-bearing loan. The investor will either receive a lump sum payment on the Debenture on a specific date (maturity date), typically one year from the date of the loan, or may convert the Debenture into Preferred Shares at a future equity financing event. The Convertible Bond does not assign any valuation to the Company at the time of signing the Convertible Bond. The future conversion of the bond into preferred shares will be based on valuation in a future funding event. The convertible bond will also have a valuation cap that limits the amount the convertible bond holder must pay for preferred shares. In addition, bonds generally allow a discount on the purchase price of preferred shares paid by future investors. Implementing this fundraising strategy with convertible bonds can be quite cumbersome from a legal point of view, not to mention that different maturity dates with different valuation caps and different interest rates are a nightmare from the capitalization table point of view. Three standard trading options are convertible bonds, SAFE bonds (Simple Agreement for Future Equity) and equity-based rounds. Here`s how they play out: After all, choosing between pre-money and post-money notes allows SAFE to transform differently, which can be more beneficial for investors or founders of SAFE. Can you learn more about the difference between pre-monetary valuation and post-monetary valuation in our article How do SAFERs and convertible notes convert in a round? SAFERs and convertible bonds will be converted into shares in a future round of valued shares; A convertible bond can be more complex when/if/how it is converted. SAFE And convertible bonds can have valuation caps, discounts and the most favored countries.
Since SAFERs are not a debt instrument, they do not have a maturity date. Convertible bonds do. This can cause problems for founders if the due date has passed before increasing a price round. In our experience, in a convertible debt agreement, there are usually 2x payment terms that can always be written into SAFE agreements. Both options have advantages in this category for seed investments that ultimately depend on your preferences. As mentioned in the definition, convertible bonds can be complicated and time-consuming. On the other hand, a SAFE is a 5-page document created to streamline the seed investment process. Since simplicity is one of the main goals, SAFE offers a simple option: SAFE does not carry an interest rate and has no maturity date. SAFE bonds are very similar to convertible bonds, but they eliminate two problematic aspects for founders – the maturity date and the interest rate. Removing these two properties from the document makes these agreements and not a loan. The valuation ceiling, discount and all other aspects of convertible bonds remain the same. A SAFE is simpler and shorter than most convertible bonds.
Suppose an investor buys $10,000 worth of convertible bonds at a simple interest rate of 8%. Suppose qualified financing takes place 24 months later, when equity is sold at a price of $4 per share. The investor`s C notes are now worth $11,600 with interest. So you would get 2,900 shares. Convertible bonds are conceptually simple, but they have some subtle details in their structure. The general premise behind a convertible bond is that you will later issue a dollar value of shares in the startup as a repayment of the initial cash investment. So instead of taking the cash investment now and immediately giving them a percentage of the business, startups offer investors the promise to convert into equity in the future on pre-agreed terms. SAFE and convertible bonds allow conversion into shares. The difference is that while a convertible bond can allow conversion at the turn of current shares or at a future funding event, a SAFE can only allow conversion to the next round of financing. As the SAFE bond is not a debt instrument, there is no maturity date.
The lack of a maturity date means that companies will not be afraid to go bankrupt, as seed investments and interests will magically mature one day. Many founders prefer SAFE because the share of ownership that the investor buys does not vary depending on how long the SAFE is held, as is the case with convertible bonds that carry an interest rate. Convertible bonds will also be raised on the basis of valuation caps. Suppose the same investor purchased $10,000 worth of C Notes at an interest rate of 8% and a valuation limit of $4 million. Suppose that in the qualifying round of financing 24 months later, the company is valued at $8 million before cash, with 2,000,000 shares and each share (as before) valued at $4 per share. The investor`s convertible bonds are now worth $11,600 with interest. At $4 a share, they would have received 2,900 shares. However, since they invested at a $4 million cap, they get 5,800 shares or twice the amount instead. As a founder raising funds with SAFE or convertible bonds, it`s important to understand what`s happening at your capitalization table and how diluted your stake as a founder is. SAFERs are convenient to use, but by avoiding equity financing and the issuance of preferred shares, founders sometimes give more of the company than they originally anticipated.
Then, when they get their first round of seed or Serie A, the dilution numbers can be quite shocking. When you send a SAFE to an investor on Capbase, our software models the dilution so that you always understand how much of your business you are selling to a particular investor. When acquiring a company, SAFERs give bondholders the choice between a payment 1 time higher or a conversion into shares at the valuation ceiling. .
