For start-ups with little or no revenue and an uncertain future, assigning a valuation sounds vague. Business valuation of any kind is never cut and dry.
Since valuation is a complex issue, start-ups who raise seed capital (Initial Investment) can consider issuing convertible securities to investors where the conversion ratio for converting the same into Equity Stock need not be decided at the time of issue. However, it is to be decided when the company raises its next round of investments (Series-A Investment). This makes it very easy for start-ups to raise funds without having to worry about valuation.
Following forms of Convertible Securities can be evaluated to raise funds without worry about valuation:
> iSAFE Note
It is a kind of convertible security that can be used in early-stage capital raise. It is neither debt nor equity. It shall be converted into equity on occurrence of specified liquidity events like next pricing/valuation round, dissolution, merger/acquisition etc.
It is a type of short-term debt financing that is used in early-stage capital raise. In other words, Debt Notes are loans to early-stage start-ups from investors who are expecting to be paid back when their note comes due. But, instead of being paid back in principal with interest, as would be the case with a typical loan, the investor can be repaid in equity in your company.
> Different components of Convertible Notes:
1. Discount: To be applied to the future valuation when it’s time to convert. Percentage of Discount can vary based on time duration to next round of investment.
For e.g. Discount rate be:
– 25% in case the investment round happens within 6 months
– 50% in case the investment round happens after 6 months
2. Valuation Cap: To set a limit as highest cap and lowest cap to the value per share that is to be used for conversion purpose.
3. Time Period: To set a definite time period by which conversion shall take place when iSAFE notes are issued.
For e.g. in case the next round of investments doesn’t occur by 2 years, seed Investments shall be automatically converted into equity shares using the mutually agreed value.
Thus, different types of Convertible Notes can be as follows:
Let us understand the concept of Discount and Valuation Cap with an example:
CA Shreyans Dedhia, Partner I’d – firstname.lastname@example.org