What Can a Startup Do with Convertible Notes When Turning into a Lifestyle Business?
When a startup transforms into a lifestyle business with minimal revenues, converting convertible notes into equity or repaying them becomes crucial for both the startup and its investors. This article delves into the scenarios and actions a startup may take when dealing with convertible notes in such a scenario.
Understanding Convertible Notes
Convertible notes are a type of loan that convert into equity at a later date, providing flexibility for both startups and investors. However, when the startup evolves into a lifestyle business, the options and outcomes can become complex. If the startup becomes a 'zombie startup' and decides to turn into a lifestyle business, the options are limited unless a compromise is reached.
Investors' Perspective
Investors generally seek a return on their investment or an exit event like an acquisition or initial public offering (IPO). In the case of a lifestyle business with low or zero revenues, the investors may choose to either renegotiate the terms, seek another investor to buy out their equity, or sue for default. Each of these options has its own set of implications and potential outcomes.
Repaying Convertible Notes
If the startup has generated sufficient capital and cash on hand, it can opt to repay the convertible notes with interest. This is typically the preferred outcome for both the startup and investors, as it provides a clear exit and return on investment. However, this is not always a feasible option, especially for lifestyle businesses with limited revenues.
Negotiating Terms
When cash is not readily available, the startup can consider negotiating terms with the investors. This could involve extending the maturity date, increasing the interest rate, or providing a premium for forbearance. These actions can help keep the investors onboard and ensure the continuation of the business.
Finding New Investors
An alternative is for the startup to seek other investors willing to lend money to a lifestyle business. Angel Investment Network, for example, provides a platform to connect entrepreneurs with potential investors. Finding a new investor willing to support the lifestyle business could help alleviate the immediate financial pressure and enable the business to continue.
Legal Consequences of Default
If negotiations and finding new investors are unsuccessful, the last resort is legal action. Investors can sue the company for default of the loan. While this may not result in significant asset recovery, it will likely signal the end of the business for the founders. Thus, it is crucial for both parties to strive for a compromise to avoid such outcomes.
Conclusion
When a startup transitions into a lifestyle business, the handling of convertible notes becomes a critical decision. By exploring options such as renegotiating terms, finding new investors, or legal action, both the startup and its investors can find a mutually beneficial solution. The key is to prioritize communication and negotiation to ensure the business continues to thrive.