For many startups, convertible bonds (also known as convertible debt) are one of the most common sources of financial support. This type of simple and inexpensive agreement helps entrepreneurs strengthen their companies and prevent it from collapsing immediately after its establishment. Despite its enticing promises, however, there is an apparent negative side to convertible bonds – the presence of debts.
In various articles, several successful entrepreneurs have noted the increase in the number of startups that are burdened with debts because convertible bonds. Perhaps some investors would argue that the bonds are nothing but equity investment. Technically and legally, however, these are still debts which are yet to be converted to equity in a future investment round.
Convertible debt is not an issue in startups that are doing well in the market. However, in bad situations, the bonds (technically, the debt) should not be seen as the company’s savior but rather its possible cause of collapse.
Some well-established entrepreneurs note that the problem with these types of financial support is that it gives the investors the opportunity to call for the debt anytime after the end of the so-called conversion period. Like what was stated, this is not an issue in successful startups. But for those that are facing problems, this might spell the company’s doomsday. Imagine an investor calling for the debt at the time of your company’s struggle to stay in the business – simply unacceptable.
With the increase in the amount of funds funneled into startups across the United States, the problem with the ballooning of debt due to convertible bonds must be addressed. This problem is not obvious in most startups in Silicon Valley. In other areas, however, it is very evident.
With this, company owners should be made aware of the negative aspects of the agreements that they are tempted to accept. In the case of convertible debts, entrepreneurs should consider looking into other possible financing deals such as what some entrepreneurs dub as the “convertible equity.”
While convertible equity has the similar functions of convertible bonds, the former’s difference from the latter is very significant: there is no debt. Convertible equity is the convertible debt without the actual debt. It still provides the investors with a discount on the company’s shares that could be realized upon conversion at a valuation. Unlike convertible bonds, however, the startups will not have the debts that could possibly affect a deal another investor or supplier.
Some entrepreneurs dispute the claims that there are problems with convertible bond agreements. The issue on whether or not to try out convertible equity, however, is out of the question especially since it avoids the complex interest rates of convertible bonds. Moreover, it also promises various payoffs such as tax benefits on the part of the investors.
The bottom line is, entrepreneurs should think through every single agreement that they are being offered with. Maybe there’s a better one out there.
More detailed information and useful advice can be found at Funded.com Created by Mark Favre, it offers expertise and assistance with developing and funding your concept, including a private forum for queries and discussions. If you need access to investors and funding providers, please do check our website.