What should the maturity date of the convertible note be?
Takeaway: The most common maturity date is 2 years. There is no hard and fast rule and it should give the company enough time to raise an equity financing round.
Convertible promissory notes have become a popular financing instrument for startups, offering a balance of flexibility and potential returns for both founders and investors. One key aspect of these notes is the maturity date, which defines when the debt becomes due and must be addressed by the startup. In this post, we will explore the factors that should be considered when selecting a maturity date for convertible promissory notes issued by startups.
Convertible Promissory Notes: A Quick Recap
A convertible promissory note is a short-term debt instrument that allows investors to lend money to startups with the expectation that the loan will convert into equity during a future financing round. This conversion typically occurs at a discount or cap on the conversion price. The note has a maturity date, which is the deadline for the startup to either repay the principal amount and any accrued interest or convert the debt into equity.
Importance of the Maturity Date
The maturity date plays a crucial role in the dynamics between the startup and the investor. It serves as a timeline for the startup to achieve certain milestones, such as securing additional financing or reaching profitability. The maturity date also provides a degree of protection for the investor, as it establishes a point at which the debt must be addressed, either through repayment or conversion.
Factors to Consider When Selecting a Maturity Date
Time Horizon: The maturity date should be set with a realistic time horizon that allows the startup to make significant progress in its growth and development. This typically ranges between 18 to 36 months, giving the company enough time to reach critical milestones, such as product development, market traction, or revenue generation.
Expected Financing Rounds: The maturity date should be aligned with the anticipated timing of future financing rounds, such as Series A, B, or C. This helps ensure that the convertible note has the opportunity to convert into equity before it becomes due, potentially benefiting both the startup and the investor.
Market Conditions: The maturity date should take into account prevailing market conditions and the overall funding environment. In a more challenging fundraising climate, a longer maturity date may be more appropriate, providing the startup with additional time to secure financing.
Negotiation and Alignment of Interests: The maturity date is often a point of negotiation between the startup and the investor. Both parties should work together to select a date that aligns with their respective interests, balancing the need for growth and progress with the investor's desire for a return on investment.
Potential Consequences of Inappropriate Maturity Dates
Setting an inappropriate maturity date can create challenges for both the startup and the investor:
Short Maturity Date: If the maturity date is too short, it may place undue pressure on the startup to secure additional financing or achieve profitability in a limited timeframe. This can lead to rushed decision-making and a suboptimal outcome for both parties.
Long Maturity Date: If the maturity date is too long, it may reduce the urgency for the startup to achieve key milestones and secure additional financing. This can lead to a misalignment of interests and decreased investor confidence.
Conclusion
Selecting the right maturity date for a convertible promissory note is critical to the success of both the startup and the investor. By carefully considering factors such as the time horizon, expected financing rounds, market conditions, and alignment of interests, startups can set a maturity date that supports their growth objectives while providing a degree of protection for investors. Ultimately, open communication and negotiation between both parties will be essential in determining the most appropriate maturity date for a convertible promissory note.