Dissecting the Term Sheet: Convertible Notes

One question I frequently receive from our syndicate investors is “How many shares of stock am I buying with my investment? And what is the price per share?. While this is a pretty straight-forward question to answer when dealing with stock market, it gets more complex in angel investing.


When angel investing, often times you aren’t actually investing in a stock or equity round; rather, you are investing into a convertible note. A convertible note is a unique convertible equity instrument with advantages over straight equity both for the startup and investor in early stage rounds.


By definition, convertible notes are a type of short-term debt, which earns interest, then converts to equity upon a predetermined date or milestone (usually the next financing round). Additionally, the note has a conversion price, which is usually at a discount to the valuation in the next equity round of financing. Annual interest rates on notes range from 6 to 8 percent based usually on the stage of financing for the company. Generally, most notes convert within 12 months as that is the window of cash-burn the note can cover.


So why do companies use convertible notes anyway? While there are many potential answers to that question, they all boil down to one general principle: early stage companies are hard to value, and convertible notes serve as a solid compromise between investor and startup. At the earliest stages, companies don’t want to undervalue their company and sell too much of it to investors. At the same time, investors don’t want a $25 million price tag for a business still in its infancy.

Here’s an example of how it all may work:

Ed’s Pharmaceuticals is looking to raise money for their new blood-thinner drug. The science is early stage — only minimal data and still far from meeting with the FDA — but very promising. They need to raise $2 million but can’t seem to agree on a fair valuation with their lead investors that works for both sides. So, they draw up a convertible note. The pertinent terms they will need for the note are:

  • Amount to Raise: $2 million
  • Interest Rate: 8% annual
  • Pre-Money Valuation: $10 million
  • Conversion Date: Either 12 months from the close of the note or upon the first $1 million raised in the next round of Equity Financing
  • Conversion Terms


The first three points are fairly straightforward. Conversion date is a general estimation of when the company will have burned through the cash raised on the note and should be well into their next round of financing. The interest rate, as we mentioned earlier, is somewhat standard.


The conversion terms are where the note can get a bit more tricky. Usually there are two or three ways for the equity to convert that are listed in the term sheet, and the term sheet will spell out whether it converts at the higher or lowest valuation calculated by the various options. The two most common options are as follows:

  • The first, and most common option, is typically the pre-money valuation plus the amount of cash raised on the note. In this example, that would be $12 million.
  • Converts at a discount to the Pre-Money Valuation in the next round of equity financing. This is typically a 10-20% discount. So, the the valuation on the next round of financing is $25 million, the noteholders would convert at $20-$22.5 million.

The second option is where the fairness of a convertible note really comes into play. For example, if the company’s next valuation is at $25 million, then they don’t suffer from undervaluing the company in the first round and the conversion price is only 10-20% off from the current valuation. Additionally, for noteholders, they are seeing a 10-20% return on their investment in a 12 month or less period of time. Overall that’s a win-win for both sides. (If you’d like to see more about how investors can track growth in their angel investments, click here.)


Convertible notes comprise more than half of the investments angelMD has made to date. As notes convert into equity, I’ll be in touch with you to share the information on the stock price and number of shares you purchased through the syndicate. I’m always happy to chat with investors about their syndicate investments or about any of the other investment opportunities we have available on the website.


If you’d like to speak with me about the mechanics around early stage investing or about how you can get more involved in our investing process, please send me an email, or you can click here to schedule some time to chat over the phone.

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It Pays to Invest Early and Lead Syndicates: A VICIS Case Study

angelMD Senior Investment Analyst John Leader

Investing in startups is a risky business, and even seasoned investors oftentimes steer away from up-and-coming companies. The distinct fear for many prospective investors is that any invested money is gone without a market to make it liquid again should the need arise. However, this also comes with an assumption that the investment doesn’t appreciate in value over time, and that it only changes on the event of an exit.

Thanks to angelMD, this assumption is far off-base.

Tracking the growing value of a illiquid investment is easier than people believe — but not always available to the average investor. All angelMD portfolio companies are required to submit quarterly reports that detail both the narrative around the company’s progress as well as semi-annual unaudited and annual audited financial statements.

The Impact of Appreciation

A savvy investor can compare a company’s financials from quarter-to-quarter, and even year-to-year to analyze the progress of the company and their investment. Additionally, the accompanying narrative from the CEO provides insight on the company’s progress towards key milestones and objectives like FDA submission/clearance as well as clinical trial results.

These reports provide investors an inside look an otherwise privately held company, but they come at a cost — most companies will only provide them to investors to invest $250 thousand or more. That’s where the benefit of syndication via angelMD comes into play for the everyday investor: for an investment minimum of $10 thousand, we aggregate your investment with dozens of other investors to give you a seat at the table as a “Major Investor” on the company’s cap table.

While reports are a nice way to monitor your investment, many investors want to see actual appreciation in their principal balances, and that comes through follow-on rounds of investing. Most medical startups require a large amount of capital to clear all regulatory hurdles and bring a product to the commercial markets. This requires multiple rounds of financing over several years, each a different, and hopefully higher, valuation. This is where investors can see the true appreciation in their investments.

VICIS, A Case Study

A great example of this is our first syndicate for VICIS, where investors committed their funds back in January of 2016.

VICIS creates football helmets that reduce concussive impacts 20-50%. With the publicity around studies linking football with CTE, a degenerative neurological disease with a high incidence rate in football players, VICIS has been a popular startup on the angelMD platform.

In January 2016, the company was valued at $10 million. Eighteen months later, in July 2017, VICIS has over a $100 million post-money valuation.

As a result, had you invested $10,000 in the initial syndicate for VICIS in January 2016, you would be able to measure the increase in your investment’s value by factoring in the appreciation in their valuation while factoring in for dilution as well. As more individuals invest their money at a higher valuation, your early stage investment grows accordingly and is validated by their interest level.

These are real dollar figures that represent not only the growth in VICIS’ business, but also in the unrealized portfolio gains to investors. Yes these investments are still illiquid, but through follow-on rounds of investing, the market is identifying VICIS as a valuable asset that is taking positive steps towards an eventually profitable liquidity event.

Overall, just because you cannot track an investment every day like you can on the stock exchange doesn’t mean that your money just goes out of your bank account never to be heard from until an exit 2 years down the road. There are ways to track them, and through the angelMD community, we work together to do just that. A major part of my job is to speak with our valued syndicate investors to share updates on their investments and to relay any questions you may have ot the startup executives to them and get you answers — service that would normally cost six figure checks, available to all angelMD members through the powers of syndication.

If you’d like to speak with me about the mechanics around early stage investing or about how you can get more involved in our investing process, please send me an email, or you can click here to schedule some time to chat over the phone.

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