Convertible Note
What is a Convertible Note?
A convertible note is a loan that converts into equity at the end of the note term.
![cn 1](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-1.jpg)
How it Works
To grow and expand, a start-up company will need to raise money.
![cn 2](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-2.jpg)
The start-up can do this by borrowing money via a short term note (less than 10 years maturity)
![cn 3](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-3.jpg)
Or it can do so by selling stock in the company to investors.
![cn 4](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-4.jpg)
The problem facing a start-up company is they have no trading history.
![cn 5](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-5.jpg)
This adds uncertainty to the start-up’s prospects, going forward.
![cn 6](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-6.jpg)
All of this makes finding a value for the start-up company difficult.
![cn 7](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-7.jpg)
A convertible note can overcome this problem.
![cn 8](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-8.jpg)
A convertible note starts off as a loan with interest due.
![cn 9](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-9.jpg)
However, unlike regular notes and bonds, interest is not paid each year.
![cn 10](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-10.jpg)
Instead, it accumulates over the note term.
![cn 11](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-11.jpg)
Then, at the end of the note term, the note is converted into equity.
![cn 12](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-12.jpg)
Typically, this conversion occurs as part of the next financing round.
![cn 13](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-13.jpg)
Some start-ups can appear riskier than others.
![cn 14](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-14.jpg)
To compensate for the increased risk, the issuer may discount the convertible note.
![cn 15](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-15.jpg)
In other words, the investor pays less than face value.
![cn 16](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-16.jpg)
However, upon redemption, they are paid full face value.
![cn 17](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-17.jpg)
This way, the investor makes a gain on the bond price.
![cn 18](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-18.jpg)
On top of that, they earn interest income.
![cn 19](https://seeaccountingnow.online/wp-content/uploads/2021/09/cn-19.jpg)