Convertible Note: Warrants

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Understanding warrants as part of a convertible note variable for financing your startup.

Convertible Note Article continued: Variables and Considerations:

Questions to consider regarding Warrants:

Do you want to offer warrants as part of this note?

Another form of incentive to the investor is to issue a warrant, such as a 20% Warrant. This would be a possibility if no conversion discount is in place; you would do not want to do both.

Warrants give the Note holders the option to purchase additional stock for investing in the Notes. It is basically like a stock option. If the investor has put in $100K as a note, then upon the first funding round, he would have an option (warrant) to buy $20k of stock at the next equity financing price, hence the 20% warrant coverage.

The Company would prefer common stock warrants with a high price and a short duration for exercising them. Of course, the investor wants cheaply priced warrants and longer periods, usually five years, to decide if they want to exercise them.

Sometimes the "warrant coverage" increases the longer the Note remains outstanding.

Thus, other variables you define in relation to the warrant include:

Percent coverage: (as mentioned above, 20% coverage means the dollar amount of warrants he would be entitled to, based on the value of his note.)

Price per share: normally would be set at the next equity financing, but it could be a price set at the time of the note.

Expiration date: How long does the investor have before he loses his right to purchase the stock at the above price? Normally this will be in the 3-5 year range.

Tip: A 25% Conversion Discount is like a 33% warrant coverage. With Warrants the company actually will get more cash due to the exercise of the Warrants. However, in practice, most investors will not exercise the warrants unless they know they will be in the money.

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