How much does a convertible note cost? A convertible note is one kind of short-term debt that eventually converts into equity. When using a convertible note, an investor lends money to a startup as its first round of financing. Instead of repayment of the loan with interest, the investor receives shares of preferred stock in the company.
Convertible notes are appealing to investors because the investor doesn't have to determine the value of the company until after a future financing round when there is more data to base valuation.
Like any loan, a convertible note comes with terms and a legal agreement between the investor and the startup company. Many investors want to ensure that their convertible note agreement is drafted correctly, so a common question is how much convertible notes cost. Let's explore this question and go over some general information about convertible notes.
How Much Does a Convertible Note Cost?
Many business owners choose to hire a business or securities lawyer to draft a convertible note agreement to ensure that the agreement is legally binding and enforceable.
Various factors will affect the cost of a convertible note agreement, including the complexity of the note terms and the location where the investor and company are located.
Many investors consider the advantages and disadvantages of a convertible note before hiring a lawyer to draft the agreement and lend money to a company.
Some advantages of investing using a convertible note include:
- Simplicity. Convertible notes are a quick and simple form of financing for investors and companies.
- Delayed Valuation. Delayed valuation benefits both parties because a new company seeking financing doesn't have enough data to value their company for equity. An investor often ends up with a discount on securities.
Before investing with a convertible note, investors should also be aware of the following disadvantages:
- Startup Company Fails. If the startup company fails to raise additional equity financing when the convertible note matures, the company will not have the income to pay the loan or stock to issue to the investor.
As with all investments, using a convertible note carries a degree of risk for an investor.
Based on ContractsCounsel's marketplace data, the average cost of a convertible note is $595.
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Key Terms of a Convertible Note
The terms within a convertible note may vary based on the agreement reached between the company and the investor. When evaluating a convertible note, the following key terms should be addressed:
- Discount Rate. It is common for investors to benefit from an additional discount on the price of shares. This is a way to compensate the investor for their financial risk. The discount on shares can be used in the subsequent financing round.
- Valuation Cap. The valuation cap, which may also be called a conversion cap, is the price at which the note will convert into equity. When the valuation cap is lower, it benefits the investor more.
- Interest Rate. It is typical for convertible notes to accrue interest. Rather than repayment in cash, the investor is given additional shares when the convertible note converts to equity.
- Maturity Date. The maturity date designates the date that the note is due, and then the company must repay it.
Do You Pay Interest on a Convertible Note?
Yes. Convertible notes do earn investors' interest. The interest rate is typically low and will range from around 2% up to about 8%. Unlike a traditional loan where interest is paid with loan repayments, convertible note interest is paid by issuing additional stocks.
Looking for an alternative to a convertible note? Learn about SAFE Notes.
Examples of Convertible Note Projects
Convertible Note Drafting
Many startups need capital early on from investors to get up and running. Convertible notes are great options to use given the startup doesn’t need to go through a ‘priced round’, which would involve getting a valuation and selling shares.
A startup founder may pay a lawyer to draft a convertible note with custom terms they can use between the startup and the investor to secure funding. This is a more seamless way of getting funding into a startup without haggling over valuation.
An experienced lawyer can draft an effective convertible note that includes all the necessary core terms and any additional conditions the parties wish to add.
Convertible Note Review
On the flip side, an investor that is interested in putting money into a startup may receive a convertible note agreement to sign. This investor may have an interest in hiring a lawyer to review the convertible note agreement before signing, so they can make sure all of the terms and language is fair and understood.
Before signing any agreement involving a sizable transaction, it is always wise to have a lawyer review the legal language to make sure you are best protected from future disputes.
Convertible Note Disputes
Like any situation involving a legal contract, especially a contract involving large sums of investment money, disputes can arise between parties.
The best way to avoid a dispute is to have an iron-clad agreement drafted by an experienced attorney. If a dispute does arise, either party can hire an attorney to represent them in the legal dispute over the convertible note. This lawyer may help an investor recover money from a startup that acted in bad faith.
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Drafting a Convertible Note Cost
If an investor wishes to hire a lawyer to draft a convertible note, the investor will have to pay for the lawyer's time and services.
According to ContractsCounsel's marketplace data, the average convertible note drafting costs are $663 across all states.
Reviewing a Convertible Note Cost
If an investor chooses to draft their own convertible note and just wants a lawyer to review the contract before signing, the investor will still incur legal fees, but document review is typically less expensive than drafting.
ContractsCounsel's marketplace data shows the average convertible note review costs to be $481 across all states.
How Do Lawyers Charge for a Convertible Note?
Lawyers typically bill clients using one of two popular fee structures: hourly rate or flat fee. The pay schedule will depend on the attorney's preference and the type of project they are hired to complete. The client must agree to the price and the fee structure before the attorney begins work on a project.
Hourly Rates for a Convertible Note
An hourly rate fee structure is the most common fee structure used by attorneys. The lawyer will provide a client with their hourly rate, and then after the project is complete, bill the client for the number of hours spent working on the project.
The marketplace data for ContractsCounsel shows the average hourly rate for a fundraising lawyer range from $250 - $400 per hour.
Flat Fee Rates for a Convertible Note
Flat fee payment structures are becoming more common, especially when a lawyer is hired for a specific job or project, like drafting a convertible note rather than an ongoing case.
Using this fee structure, the lawyer quotes the client a flat rate fee rate to complete a particular project or job.
Even if a flat fee rate is used, lawyers may charge additional fees for revisions or reviewing the document.
ContractsCounsel's marketplace data shows the average flat fee rate for convertible note costs to be $595.
Get Help with a Convertible Note
Do you need help with a convertible note project? If so, post a project in ContractsCounsel's marketplace to receive flat fee bids from fundraising lawyers to handle your project. All lawyers on the ContractsCounsel's platform are vetted by our team to make sure you are provided with top-tier service.
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