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Many startups are looking to raise capital in the early stages of growth. Startups that need a large budget or don’t attract a lot of capital from their founders are usually looking to raise capital through convertible note. This type of loan is one of the most common ways to raise capital in the early months and years of startup activity. But do you know the formula for convertible notes? In this article, we want to talk to you about this formula. If you are one of the founders of a startup that is going to attract your desired capital in this way, this article will be useful for you. So join us.
Loans can be converted into equity
Before reviewing the convertible note formula, it is best to look at the definition of a convertible note. Each startup has 100 shares, which is its most valuable asset. In fact, all startups have equity, but not all startups have money. That’s why startup owners are trying to sell their stocks to someone who is going to pay them.
A convertible note is a type of short-term debt that can be converted into equity for money lenders. This type of loan is usually done by venture capitalists or angel investors. This method of investment is usually the first type of budget payment to startups during the lifetime by investors. Instead of asking for a refund, investors decide to acquire ownership of the company through stocks. This type of convertible note has so many benefits that many startups are looking for it when they don’t have the cash.
This type of loan is calculated through a convertible note formula. There are many formulas for calculating this type of stock that investors or startup founders calculate and execute due to their agreement. We will discuss this formula below.
What is a convertible note formula?
In calculating this formula, the percentage that the investor obtains from the stock is to be calculated. This formula is actually a two-way formula (because, for example, an investor may refuse to convert a loan into equity). There are also many components involved in calculating this type of loan.
For example, one of the most important components of this formula is the price and value of the startup before investing. Calculating the value of a startup should be measured through other formulas and with other components. If you are not aware of the value of a startup, it is best to contact the consultants in this area to determine the value of your startup. Without knowing the value of a startup, you can’t calculate the formula for a convertible loan.
Convertible note calculation formulas
Now, we will review the formulas. The first formula you need to calculate is as follows
V1 = 1 – D
In this formula, D is the discount rate. The V1 variable is supposed to be one of the options that affect the value of the startup. You should consider the lowest number between V1 and the company’s value cap as the company’s value. We show this value with the variable V2.
Now, to calculate the next part of this formula, we need to calculate the capital and the amount of the penalty. If the founders fail to attract capital within three months, they must undertake to pay the investor the amount of the contractual obligation due to the delay for damages resulting from this delay. Sometimes this figure can be agreed without calculating the formula between the parties but using a part of the convertible note formula, this penalty can also be calculated.
F = The amount of the penalty in Rials
M = The number of months between the start of this contract and the conversion of capital into equity
L = The amount of capital in Rials
F = 0.35 × L × M
Now that we have calculated the penalty amount, we add it to the amount of capital that is to be attracted. We need to divide this number by the value of the startup, or V2 variable.
After calculating this number through the convertible note formula, we find out that this amount is not yet in the form of a percentage and must be multiplied by 100 to convert it into a percentage. When we multiply the result of the division by 100, the number obtained reaches a percentage scale. This number (which we show by the letter p) is the investor’s share.
P = [(L + F) / V2] x 100
How to use the formula?
Once you have calculated the formula, you can present it to the investor. This number is actually the amount that the investor is going to receive in exchange for the amount paid to the startup (L). There are other formulas that calculate convertible note. There are also tools that calculate this formula and give it to you.
The final word
In this article, we reviewed the convertible note formula and we saw what components are influential in this formula. We also talked about the ways to calculate this formula. If you think that this method is still difficult for you to calculate or that other components are important to you or the investor and you should consider them, it is better to refer to consultants in this field such as Retiba experts to both determine the value of your startup and calculate the formula for a convertible note.