Selling Your Startup with Convertible Debt

I previously mentioned that convertible debt is a good way to raise capital for most startups. The main reason why convertible debt is beneficial for startups is that it delays coming up with a valuation figure at the seed stage–the valuation conundrum is essentially punted to the Series A (or “qualified financing” stage).

But what happens to the convertible debt if you sell rather than raise capital?

In most situations, the investor will receive more than the interest due + principal balance of the loan. I’ve seen anywhere from 1.5X-3X the outstanding principal amount of the loan due the investor upon the closing of the “change of control” event. This 1.5X-3X payment is, of course, made in full satisfaction of the startup’s obligations to the convertible debt investor.

In this unique situation, your startup essentially skips the “qualified financing” and goes straight to the exit. If the convertible debt investor wasn’t able to enjoy the upside in the event of an acquisition, such investors would be more reluctant to invest this way (and you’d be left to grapple with the valuation debate). Or worse, the investor would demand a higher interest rate. Or much worse, they would require their consent to prepay the convertible note before the qualified financing or maturity date of the loan.

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2 thoughts on “Selling Your Startup with Convertible Debt

  1. Ryan,

    Thanks for all of the great info. So in the scenario above the angel would only receive the agreed multiple on the outstanding debt? Do they also get to participate in any of the upside? For example 500k angel round 3x multiple on "change of control event". company sells for $10MM. Angel gets only $1.5MM? Do they participate in the remaining upside?

  2. […] Event Payment: How much (e.g., 2X/3X, etc.) do the convertible debt holders receive if the startup gets acquired before a qualified financing and the maturity date? What is the definition of “Liquidity […]

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