When a new startup goes out to seek money for the first time, they often can’t get a high enough valuation to make it worthwhile to raise money. Instead of taking money as purchase of stock and equity, you will often take it as convertible debt. The way convertible debt works is you give out a promissory note to the person who is investing the money which converts over into equity at some future event, usually when you go out to raise your next round of money. It usually converts at a discount. If you’re going to raise your next round of money within a month or two, the discount might be ten or twenty percent. If it is going to be months before you raise your next money, the discount might be as much as fifty percent. Convertible debt works at the beginning when you can’t get your valuation, but the risk is if you hit the next round and you don’t get a high value, you’re going to get exceptionally diluted. Handling convertible debts is a process that requires a lot of thought.
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