What Are Common Negotiation Points in Convertible Notes in India?
In the competitive landscape of Indian startups, convertible notes have become the financial instrument of choice for many. They provide flexibility for both founders and investors, granting a precious runway for startups to grow while offering investors a viable entry point. As essential as they are, understanding the negotiation points within convertible notes is crucial for any founder looking to secure funding while maintaining company health and growth potential.
Conversion Terms
The core of a convertible note is its ability to transition into equity. Founders and investors typically haggle over the conversion price, which dictates the equity amount. The investor seeks to minimize this price to maximize their share, whereas the founder’s goal is quite the opposite. A lower conversion price can entice investors but dilute your equity significantly upon conversion. Discounts serve as a reward for early risk, allowing investors to convert at a price lower than future financiers. On the other hand, a valuation cap can be a blessing, ensuring that no matter the company’s value at conversion, the investor won’t get more than a pre-determined percentage of the company.
Interest Rate
Convertible notes aren’t gratis; they accrue interest. This rate can be a sticking point, with startups eyeing lower rates to reduce repayment amounts and investors bargaining for higher rates to reflect the investment risk. Striking a balance is a dance between not hampering the startup’s growth and providing the investor with fair compensation.
Maturity Date
The ticking clock of a maturity date adds tension. Founders typically aim for a more extended period to avoid a cash crunch when repayment is due or to have ample time to hit milestones for a favorable equity valuation at the time of conversion. Investors, conversely, may push for a shorter horizon to gain either their returns or equity sooner.
Repayment Terms
Should the note not convert, the plan B is the repayment. Options range from cash payouts to issuing new notes or equity. These terms are of special interest for investors, who will want assurance of some return on their investment. Founders must negotiate terms that won’t hamstring their company’s finances if they have to repay instead of convert.
Investor Rights
Rights are the levers of control and assurance in a convertible note. Information rights can allow investors a peek behind the curtain, board observer rights a seat, albeit muted, at the decision-making table, while anti-dilution provisions and pro-rata rights safeguard their investment’s value. Investors may push for a larger set of rights, but founders must ensure they don’t cede too much control or future flexibility.
Events of Default
The ‘what ifs’ of a default scenario loom ominously. Setting clear definitions for what constitutes a default is as important as determining the subsequent remedies available to the investor. It’s about balance—ensuring investors are protected without placing the startup in a stranglehold of potential penalties and demands.
Governing Law and Jurisdiction
Legalities can’t be overlooked. Since laws vary considerably across borders, choosing a governing law and jurisdiction that both parties are comfortable with is crucial. The startup’s location and the investor’s reach often influence this choice. This technicality, though drab, can significantly impact how disputes are resolved and what rules apply.
Throughout these negotiations, there’s a delicate interplay between protecting the startup’s interests and providing clear incentives and safeguards for investors. Both parties are best served by an arrangement that aligns their goals for growth and return.
Key Takeaways
- Negotiation of conversion terms should balance investor incentives with founder equity.
- Interest rates must be fair yet not burdensome to the startup’s growth.
- Maturity dates and repayment terms should provide runway for startups while offering investor return assurances.
- Founder control and company direction must remain intact while honoring investor rights and protections.
- Establish clear definitions and reasonable remedies for events of default.
- Choose an applicable governing law and jurisdiction that ensures fair dispute resolution.
Questions to Ask Yourself
- Are my proposed conversion terms reciprocal between investor interest and my stakes as a founder?
- Have I balanced interest rates to reflect risk without hindering growth?
- Is the maturity date conducive to my startup reaching significant milestones or future funding rounds?
- Do the repayment terms allow for realistic payback scenarios without devastating the startup?
- Have I maintained the necessary control over my startup while negotiating investor rights?
- Are the events of default and the governing law and jurisdiction in these negotiations in my startup’s best interest?
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