That is convertible debt, which is a loan (debt) that can be converted into ownership (equity). If the company has financing in the future, convertible debt will usually be converted into equity. . The simple fact is: since savvy venture investors prefer convertible debt investment, entrepreneurs should choose it. After all, it's a great way to get investment without valuing the company. Because the valuation of start-up companies or companies that have not yet generated revenue is difficult to predict and often has great disagreements, choosing convertible bonds can also prevent early investors’ interests from being diluted in the next round of financing. Simulation case Take a look at this example. You start your own company, let's call it Rapid Growth Inc. or RGI for short, and you believe that the best way to make it successful is to get a large equity capital investment from an institutional venture capitalist. . You know that attracting this kind of investment won't happen quickly, but you now desperately need the funds to get RGI up and running and win some customers to prove the viability of your business model. So, you want to raise money through angel investors that friends, relatives, or others have mentioned. So what financing method should you use to negotiate with these early investors? If you believe RGI needs venture capital, convertible debt may be a better choice than direct debt or equity financing. The main reason for this is that you don’t need to value your company before institutional investors come in. Everyone knows that judging the value of a startup is very arbitrary, and entrepreneurs who raise funds through relatives and friends can easily overvalue their companies. Convertible bonds eliminate the risk of depreciation (i.e., the company's equity is valued at a lower value than before). In the case of RGI, if you choose to use the equity financing option, you may value the company at $2.5 million before raising money (this is a round number chosen by many first-time entrepreneurs). If you raise $500,000 from relatives, friends, and business angels, the value of the business becomes $3 million after investors come in. If an institutional investor is willing to invest $2 million in RGI, but he thinks your company is only worth $2 million, then you have to convince your relatives and friends to accept this new investment, but they will be disappointed because the institutional investor The price of entry is lower. (In this example, it will be 33% lower than the first round of financing. If the deal is completed, the later institutional investors will hold 50% of the equity for US$2 million, and the previous investment of US$500,000 will be diluted to 8.33%.) But if the initial $500,000 you raise for RGI is in the form of convertible debt rather than equity financing, your relatives and friends will benefit more later. Their risk is lower because even if it takes you a long time to get a second round of investment, their borrowing will accrue interest accordingly. In this way, when new investors come in, they will not dilute their interests due to new financing. (In the above example, if the $500,000 they previously invested was converted into shares in the new round of financing at the latest company valuation, they could hold 12.5% ??of the shares, not just 8.33%.) In addition, convertible debt financing Agreements often also include clauses promising that the company will give the borrower a discount or pay a dividend when the debt is converted into equity. In other words, by negotiating with institutional investors, your friends and relatives may convert their debt into equity at a lower price. The specific discount is determined through negotiation. According to experience, it is best to pay 20% to 25% per year. ratio. So, if it takes you six months to complete your next round of financing, and you calculate it at a discount rate of 24% per year, then regardless of the company’s valuation, your relatives and friends will still enjoy a higher conversion price than the new round of investors. 12% lower. While traditional venture capitalists would argue that every issue in an investment is negotiable to their best advantage, these terms can act as leverage. Three key points: If the convertible bond financing method is really as good as what we said above, why is it not widely adopted? An important reason is that operating convertible bonds requires a lawyer to draft relevant terms, which is too costly for an entrepreneur who is still in the early stage. A bigger reason may be that entrepreneurs are afraid of debt: The mere thought of taking on $500,000 in debt is enough to make any business owner cringe, let alone a fledgling entrepreneur.

Ironically, this fear of debt prevents companies from successfully raising capital. In the process of using convertible bonds for financing, you need to make the following three important decisions: ■Are there any discounts for converting convertible bonds? Offering favorable terms to early investors is a complex decision. However, if you do not provide discounts or the discounts provided are too low, it may hinder the smooth progress of the company's next round of financing due to different opinions among investors. But if you give investors overly favorable terms (or if you take a long time to raise the next round of financing without limiting the degree of preferential treatment), the next round of investors may take this into consideration when valuing your company. factor. This likely means that, as an entrepreneur, you will sell your equity because of the overly generous terms initially formulated. Please be wary of this issue. In short, when you use convertible debt to raise money from family, friends, and angel investors, you can tell them: I need money, and you have some. But now I don't know how much my company is actually worth, I can only give an upper limit consistent with the risk, let's see if professional investors will make a judgment, or let time decide. (Translation/Huang Jie)