Convertible Debt – Is it Debt or Equity?

What is convertible debt and why is it used?  Is it debt or equity?  Well, it’s a little of both.

Essentially, convertible debt is a loan where the lender can exchange the principal and accrued interest for equity at a predetermined valuation.  It is commonly used by start-up companies that are in growth mode (i.e., they have a proven product or service offering and are generating revenue but need capital to grow).  The conversion feature is added as a way for private third-party lenders to benefit from the continued growth.  However, the underlying debt terms are in place to protect their interests.

The key terms for a convertible debt offering will include the following:

• Interest Rate – the cost of the money that is being borrowed
• Maturity Date – when the underlying debt matures
• Discount Rate – the discount to the future valuation of the company where a bondholder can convert the debt into equity
• Valuation Cap – the upper limit on the price at which the debt converts into equity

If you are interested in learning more about this type of growth capital, check out some of the articles below:

• Convertible Notes (aka Convertible Debt): The Complete Guide | Startups.com
• Key terms in a convertible note – FasterCapital
• The Pros and Cons of Convertible Notes | Toptal®
• Convertible Debt For Startups: The Complete Guide (bondcollective.com)

Next week, we will discuss a Preferred Equity (or sometime referred to as a Series A).

Here are a few other things that may be of interest:

• Compliance Guide for Small Business Ownership Regulations Causes Concern (nfib.com)
• Main Street Hurt by Employee Retention Tax Credit Delay (nfib.com)
• Pennsylvania Legislative Update – NFIB
• The Main Reasons Why the Sale of Your Business Can Fall Through (thenybbgroup.com)
• Help Buyers to Understand How You Excel (thenybbgroup.com)
• Economic Review: Q4 2023 – Silvercrest (silvercrestgroup.com)
• Data Driven Change Management (eisneramper.com) (10/25 2-3pm EST)
• Year-End Tax Strategies (eisneramper.com) (11/20; 12-330pm EST)

As always, please don’t hesitate to email myself (jsanders@mpl-law.com), Andy Miller (amiller@mpl-law.com), Christian Miller (cmiller@mpl-law.com), Erik Spurlin (espurlin@mpl-law.com), Brad Leber (bleber@mpl-law.com) or anyone in our office with questions or comments.  

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