The vast majority of high-growth start-ups depend on some form of debt financing, such as angel funds, traditional venture capital, wealthy investors or friends and family. While identifying a viable market and creating a large pitches are essential to obtaining investment financing, there seems to be an endless series of other considerations that need to be addressed before these funds appear in your bank account and you are running to create the next big thing. In this article, I will address one of the most important decisions that most entrepreneurs and businesses must make when raising investment funds, and that is the throes and cons of using convertible bonds to finance your business. It is important that the same result occurs when the debt is converted into LLC equity instead of being repaid. In this case, debt-to-equity conversion is considered a debt repayment and LLC members would continue to be treated as a cash distribution equal to the “repaid” debt. If members have used their losses to offset other revenues, LLC`s seemingly non-existent convertible debts can generate a taxable profit for members if these debts are repaid. As a result, debt-financed LLC members could end up in significant tax liabilities, particularly if the LLC does not distribute these taxes in cash. Convertible bonds are debt securities that include maturities such as maturity date, interest rate, etc., but are converted into equity when a future capital cycle is raised. The conversion is usually done with a discount on the price per share of the future round table. In short, convertible bonds are originally structured as bonds, but they have a provision that allows the capital plus accrued interest to later turn into equity. This allows the initial investment to do more quickly with lower legal fees for the company at that time, but ultimately gives investors the economic commitment of a stake.
Maturity date: Convertible bonds have a maturity date at which bonds are due and payable to investors if they have not yet converted to equity. Some convertible bonds have an automatic conversion at maturity. LLC members should check whether convertible bonds are the significant risk or costs that may be imposed on the LLC and its members. LLC members, who expect a long-term commitment to the LLC structure and smooth navigation in their commercial efforts, may be well placed to issue convertible debt. For many others, including CTCs, for which it is possible to move to the form of the business or if an upward trend in the business model increases the risk of insolvency or bankruptcy, a series of basic LLC capital may be the best way to proceed. Valuation ceiling: In addition to the conversion discount, convertible bonds generally also have a valuation ceiling that is a severe cap on the conversion price of bondholders, regardless of the price per share in the next capital financing cycle. As a general rule, all automatic conversions made on the due date (if no qualified financing has taken place) are at a price per share below the valuation ceiling. Example: A start-up company with 1,000,000 common shares concludes a starting financing cycle of $1,000,000 in the form of a convertible bond with a valuation ceiling of $5,000,000 before the money is assessed in the next round of financing.