It is also important to decide on what happens if the notes do not automatically convert prior to the expiration of the term and what rate will be applied to the conversion. Typically the rate used is calculated based on the share price offered in the round, or the share price for a stock exchange listing.
Interest can be applied to the loan amount, which is then reflected in the conversion to equity. In conjunction with or in place of interest the loan can convert to equity at a discounted rate. In either case, the rationale is that people or entities that invest in your company at the early seed stages (which is when investors also take on the most risk as there is less evidence of your company’s potential to succeed) should be rewarded for their faith.
Convertible notes are most common at the seed stage or as a method of bridging finance though they can also be used when the valuation of a company is in doubt.
Convertible notes, while easy to execute with Australian Securities Investments Commission (‘ASIC’) are not always the most appropriate for the circumstances.