How Much of a Discount Should You Offer On a Convertible Note?

Updated on June 11th, 2022
Discounts on a Convertible Note

The advent of convertible notes have made it more simple to invest seed money into a promising company. Convertible notes act as loans with certain provisions to protect the company. As well, they incentivize the risks involved for an investor, without requiring a lawyer, as one would with a real equity investment.

Instead, a convertible note carries with it a means of investment, which accrues interest (somewhere between 4% and 8% depending on where the investor and founder land), sometimes a cap (a maximum valuation that has been set to protect the investor against potential equity dilution, in the case of an unexpectedly large next round funding).

Why Offer Discounts at All?

Making any investment at all in a company this early carries more risk than any other subsequent phase. A discount is built into the agreement to make the deal a little more amenable to the aims of investors. The agreement allows early investors to purchase shares upon conversion with their investment plus accrued interest. All of the while, at a lower price than later stage investors.

If a company sells their equity at a $1.00 per share but the discount rate on their convertible note is 20%, new investors would have to pay that rate. However, the convertible note holder would be able to purchase shares at $0.80.

Discounts Vary Based on Maturation & Risk

Most discounts range between 15% to 40%, with a concentration around the lower end of that scale. However, more perceived risk associated with the company may justify or even require a higher discount. For instance, a longer maturation date or any specific concerns regarding the company.

Typically, a maturation date within the first six months will carry with it a 15% discount on shares upon conversion; the discount should be upped to 25% between 7 to 12 months. A year or more would call for a 40% discount for shares.

John Rampton

John Rampton

John Rampton is an entrepreneur and connector. When he was 23 years old, while attending the University of Utah, he was hurt in a construction accident. His leg was snapped in half. He was told by 13 doctors he would never walk again. Over the next 12 months, he had several surgeries, stem cell injections and learned how to walk again. During this time, he studied and mastered how to make money work for you, not against you. He has since taught thousands through books, courses and written over 5000 articles online about finance, entrepreneurship and productivity. He has been recognized as the Top Online Influencers in the World by Entrepreneur Magazine and Finance Expert by Time. He is the Founder and CEO of Due.

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.
Categories

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More