Raising capital is a pivotal moment for any business, regardless of its size or stage. Whether it’s to fund a new project, expand operations, or simply to bridge a gap in cash flow, securing investment can be a complex and time-consuming process. A major hurdle often lies in the valuation of the company. Determining a fair and mutually agreeable value can lead to protracted negotiations and delays, potentially causing you to miss critical opportunities. If the valuation is too high, it might deter potential investors; if it’s too low, it can result in significant dilution for existing shareholders. This dilemma often creates a bottleneck that slows down a company’s momentum.
This is where the convertible note emerges as a flexible and strategic solution. So, what exactly is a convertible note? In essence, it’s a short-term debt instrument that a company issues to an investor. The key difference from a conventional loan is that this debt is not repaid in cash. Instead, it is designed to convert into company equity (shares) at a later date. This conversion typically happens when the company secures a subsequent, larger funding round, often called a “Next Equity Financing.” Think of it as a financial bridge: you secure the funds you need today with the promise to settle the debt with company ownership in the future, once the company’s valuation is more clearly defined. The convertible note elegantly solves the problem of premature valuation, allowing funding to proceed quickly and offering benefits to both the company and the investor.
While a convertible note is fundamentally a form of debt, it includes several distinctive features that differentiate it from a traditional loan. These components are structured to balance the interests of the company and its investors.
Imagine a medium-sized company needs IDR 10 billion to launch a new product line but is hesitant to undergo a formal valuation. An investor is willing to provide the capital. Instead of a drawn-out valuation debate, both parties agree on a convertible note with a principal of IDR 10 billion, a 5% annual interest rate, a 2-year maturity date, a valuation cap of IDR 50 billion, and a 20% discount rate.
Eighteen months later, the company’s new product is a huge success, attracting a private equity firm that invests at a post-money valuation of IDR 200 billion. The convertible note now converts into equity. The investor’s total investment becomes IDR 10 billion plus accrued interest. The conversion price will be based on whichever is lower: the price per share at a IDR 50 billion valuation (the cap) or the price per share with a 20% discount on the IDR 200 billion valuation. The investor benefits from their early commitment, and the company secures vital funding without the initial valuation hassle.
Using a convertible note offers significant benefits for companies:
Investors also have strong reasons to favor a convertible note:
A convertible note also carries risks that you must carefully manage despite its advantages:
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Indonesia primarily governs a convertible note under the legal framework for debt instruments. A convertible note agreement is a legally binding debt contract. Relevant regulations include the Indonesian Civil Code (Kitab Undang-Undang Hukum Perdata) and Law No. 40 of 2007 on Limited Liability Companies (UU PT). The UU PT outlines the procedures for capital increases and share issuance, which are vital for the conversion process. You must ensure that the company’s articles of association permit such transactions and obtain the necessary approvals, such as from a General Meeting of Shareholders (RUPS).
A robust convertible note agreement must clearly define all terms to be legally sound and protect all parties. Key elements include:
Before signing a convertible note, both the company and the investor must conduct thorough due diligence.
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At Kusuma & Partners Law Firm, we see the convertible note as a powerful tool for business growth, but one that requires expert guidance. Many companies, whether established or growing, fall into the trap of using generic templates or overlooking critical legal details. A poorly structured convertible note can lead to significant problems down the line, from disputes over valuation to unexpected dilution.
Our approach is to serve as your strategic legal partner. We work with you to understand your business objectives and draft an agreement that is not only legally sound but also aligned with your strategic goals. We simplify complex legal language, guide you through negotiations, and ensure that every clause of the convertible note protects your interests. With our experienced team of corporate lawyers, you can focus on executing your business plan with the confidence that your legal foundation is secure.
The convertible note is an invaluable financing tool in the Indonesian market, offering a flexible and efficient way to raise capital while deferring the complexities of valuation. It provides a strategic advantage for companies seeking to grow and for investors looking for an early entry with built-in protections. However, its effective use depends on a deep understanding of its mechanics and the underlying legal framework.
Don’t let legal complexities or a rushed process undermine your business’s potential. Take a proactive step to secure your company’s future. Contact us today for a comprehensive legal consultation and customized legal solutions for your financing needs. Let us help you build a solid and secure legal foundation for your business’s success.
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“DISCLAIMER: This content is intended for general informational purposes only and should not be treated as legal advice. For professional advice, please consult with us.”
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