Convertible notes are fairly commonplace when it comes to externally funding your startup. Yes, a lot of people nowadays start their business by bootstrapping, but personal funds usually only last so long before you need external sources of funding. Convertible notes are generally used in this process to make the seed rounds less cumbersome. Here at Appifany, we've had a bit of experience with these, so here's all the basics you need to know.
Suggested Background Reading
Before getting straight into it here's a couple of our articles on startup funding that you might want to familiarise yourself with first: 3 Stages of Securing Funding for Your App, and How Much Will My App Cost to Develop.
These two articles discuss some of the basics of many important economic concepts and practices of which startup founders must be aware and on which today’s article is based.
What Is a Convertible Note?
In order to accurately explain what a convertible note is we must first address the essential circumstances that give rise to their demand in the first place. Startups often experience difficulties trying to raise adequate sums of money from investors during the first round of fundraising (i.e., the “seed” round).
There are various reasons why this is so but most important for our purposes here is the fact that it’s usually quite challenging for a startup and/or potential investors to accurately devise a “valuation” —i.e., an estimation of a company’s worth—that makes sense. Indeed, how does one justifiably decide upon a valuation if a startup comprises, for instance, 2 founders and a solid prototype rather than 3 founders and a convincing pitch deck or 1 founder and several hundred pre-orders for a forthcoming product?
It seems clear that there’s no objective way to perform these calculations at a time when a startup has yet to collect adequate metrics. Convertible notes function so as to allow early-s