If you’re a seed or early-stage startup in need of funds for hiring and operations, you may find it difficult to determine a fair valuation. That’s where convertible notes come in.
A convertible note is a short-term debt instrument that startups can use to raise funding. It allows holders to convert their debt into equity in the company at a future date. The biggest advantage of convertible notes for early-stage startups is that they don’t need to determine the value of the company when issuing them.
Unlike traditional equity financing, issuing a convertible note is quick and efficient. There’s only one document to deal with, which saves time and money for both the company and investors.
Until 2016, convertible notes were not legally recognized in India. However, the Companies (Acceptance of Deposits) Rules, 2014 were amended to recognize them as a fundraising instrument for startups.
DPIIT-registered startups can now raise funding through convertible notes, subject to certain conditions. The investment amount must be at least INR 25 lakhs in a single note and converted within 10 years. The terms of conversion must also be determined upfront.
By linking convertible notes to expected returns instead of valuation and percentage of ownership, startups can avoid the valuation quagmire that often comes with very early-stage investments.
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