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6 Things to Know About Raising Start-Up Capital Through Convertible Notes in New Zealand

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Raising capital is a significant step in the journey of any start-up. Businesses often have to explore various funding avenues to meet their funding needs. One financing tool that has gained popularity in recent years is convertible notes. This article will take you through six key things to know about raising start-up capital through convertible notes in New Zealand.

1 – What Are Convertible Notes? 

Convertible notes are a type of debt a business can convert into equity under certain conditions. These conditions are usually predefined. 

When a start-up issues convertible notes, it borrows money from investors, understanding that the debt will later convert into equity.  Usually, this conversion will occur during a financing round.  This flexibility makes notes an excellent option for start-ups, particularly those in the early stages of development.

2 – What Are the Advantages of Convertible Notes?

The multiple advantages of convertible notes make them a popular choice for start-up fundraising in New Zealand.  These advantages include the following:

  • Quick and straightforward: Issuing notes is generally a faster and simpler process than traditional equity financing rounds;
  • Delaying valuation: Notes allow start-ups to postpone the valuation discussion.  This means there is more clarity about the company’s financial performance.  This can be beneficial for both founders and investors; and
  • Lower interest rates: Notes usually have a lower interest rate than traditional loans. 
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3 – What Are Their Key Components?

Start-up founders need to familiarise themselves with the key components to navigate the world of convertible notes effectively.  This includes the following:

  • Conversion discount: This is a percentage discount when the note converts into equity. It rewards early investors who take on more risk than later investors; 
  • Valuation cap: A valuation cap sets the maximum valuation at which the note converts into equity. This protects early investors by ensuring they receive a fair share of ownership, even when the start-up experiences significant growth before the conversion; and
  • Maturity date: Notes come with a maturity date, at which time the notes either convert into equity or are repaid with interest, depending on the terms of the agreement.

4 – How Do I Determine the Right Time for Convertible Notes?

Choosing the right time to issue notes is crucial for maximising their benefits. Notes are well-suited to early-stage start-ups without an accurate valuation. 

By delaying the valuation conversation, founders can focus on building the business before assigning it a specific value. For this reason, notes are often used as a financing tool that bridges between early-stage funding rounds. They provide start-ups with the capital needed to reach critical milestones and attract more significant investments in the future.

5 – What Are the Regulatory Considerations?

Compliance with New Zealand’s regulations is paramount when raising capital through convertible notes. For example, New Zealand’s regulatory framework governs the issuance of such securities. In particular, the Financial Markets Conduct Act oversees convertible notes. Start-up founders must know the legal requirements and disclosure obligations under this act. 

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Seeking advice from a lawyer can help ensure compliance and minimise legal risks. For example, an experienced lawyer can help draft the convertible note agreement and ensure it aligns with relevant regulations.

6 – How Do I Communicate Effectively with Investors? 

Clear communication with investors is vital to a successful convertible note issuance.  This includes:

  • ensuring that the terms of the notes are transparent and clearly communicated to investors;
  • keeping investors informed about the start-up’s future funding plans; and
  • providing regular updates on the company’s progress and milestones.

Key Takeaways

Start-ups often have to explore various funding avenues to meet their funding needs.  One financing tool that has gained popularity in recent years is convertible notes.  

Some key things to understand about convertible notes include:

  • what they are;
  • their advantages;
  • their key components;
  • the most appropriate time to utilise notes;
  • the regulatory considerations involved with their use; and
  • how to effectively communicate with investors.

If you need assistance understanding how you can use convertible notes to fund your New Zealand start-up, you can contact our experienced business lawyers to assist as part of our LegalVision membership. You will have unlimited access to lawyers who can answer your questions and draft and review your documents for a low monthly fee. Call us today at  0800 447 119 or visit our membership page

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