Overview of a Convertible Note Subscription Letter

What is a Convertible Note Subscription Letter?

A Convertible Note Subscription Letter is a letter for an investor to subscribe for a convertible note.
The terms of subscription set out in a Convertible Note Subscription Letter can be different from an investor to investor, for example, one investor may be entitled to pro-rata rights while another is not.

What is a Convertible Note?

A Convertible Note is a form of debt or investment. Basically, it is a short-term loan typically used in a startup environment. A Convertible Note is used by businesses to raise money. They can do so either through Convertible Notes or Equity. A Convertible Note is a loan that turns into ownership in the company.

For example, A wants to start some business and is actively looking for capital, and B truly believes in A’s idea so he agrees to a Convertible Note. The investor loans an entrepreneur money, which will later convert into equity in the company.

Some features of Convertible Notes are:

Interest Rate: As an entrepreneur borrows some money from the investor, so he/she will have to pay interest on that money in the form of equity.

Discount: after the convertible notes are converted into equity the investor may get a discount while buying the new equity.

When to use a Convertible Note Subscription Letter?

When an investor is interested and ready to invest their money for any idea, they will make the investment as a Convertible Note. So, a Convertible Note Subscription Letter will help them to invest and also acts as legal proof of investment in case of any dispute in the future.
A convertible note is a debt instrument that converts into equity under predefined conditions. If there are multiple investors subscribing for the same note, a Convertible Note Instrument should be used, followed by a Convertible Note Subscription Agreement for each investor.

Pros and Cons of Convertible Note Subscription Letter

One of the main advantages of issuing convertible notes to investors as opposed to conventional debt financing is that it does not force the issuer and investors to determine the valuation of the company. This is especially useful in the case of startup companies as it may be difficult to determine the definitive valuation of a business that has yet to be taken into its true fruition.

However, while convertible notes can be used to decrease risks associated with the ambiguities of valuation during the early stages of a startup company, there are also numerous disadvantages and areas of contention that may discourage investors from choosing this method of funding. For new investors and entrepreneurs investing in a company for the first time, it can be difficult to determine whether the terms of a particular convertible note offer are fair or not, and thus, failing to provide the same sense of assurance and security as normal investments.

Conclusion

A Convertible Note Instrument is a debt instrument that converts into equity under predefined conditions, typically in qualified financing, at a liquidity event, or on the maturity date. To raise funds by issuing convertible notes, one should either use a Convertible Note Instrument or a Convertible Note Subscription Letter.

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