Convertible Note

A convertible note sets out a defined list of terms.

The principal amount.

Interest, which may accrue and convert with the principal rather than being paid in cash.

The discount and the valuation cap.

The conversion trigger: what counts as a qualifying financing, usually a priced equity round raising above a stated amount.

What happens on a sale of the company before conversion, commonly a multiple of the principal or conversion at the cap, at the holder's election.

The maturity date, and what happens if no qualifying round has occurred by then: repayment, conversion at a stated valuation, or extension.

And whether the holder has any information or consent rights before conversion.

That maturity provision is the one founders should read carefully. A note that becomes repayable in cash at maturity, in a company with no cash, is a problem rather than a bridge.

Three Nigerian points matter beyond the standard mechanics.

Capital importation. Where the investor is foreign, the money should come in through an authorised dealer bank and a certificate of capital importation should be obtained for the inflow. A note funded without one leaves the investor with no documented route to repatriate proceeds later, and it surfaces at exit rather than at investment.

Conversion mechanics. Converting a note into shares is an allotment, with everything that involves: board resolution, entry in the register of members, share certificate, and the return of allotment filed at the CAC. Where the company also needs to increase its share capital to accommodate the issue, that is a further resolution and filing with fees assessed on the increase. Nigerian companies routinely convert notes commercially and never complete the corporate steps, which produces a cap table that does not reflect reality.

Dilution modelling. Founders consistently underestimate the effect of notes. Money raised on a note does not dilute anybody on the day it arrives, which feels painless, and then converts at a discount to a cap at the next round, sometimes taking considerably more of the company than a priced round would have. A founder with three outstanding notes should model conversion before agreeing the terms of the next round, not after.

The practical advice is to keep notes few, keep the terms consistent, and model the cap table including conversion every time a new instrument is issued.

Three ways to take early investment, differing in what is agreed now.

A convertible note is debt. It carries interest, has a maturity date, and ranks as a creditor claim until it converts. If no qualifying round happens, repayment can become due.

A simple agreement for future equity is not debt. There is no interest and no maturity, and the investor has no repayment right. It converts on the same kind of trigger, with a discount and a cap, and it is simpler and more founder friendly.

A priced round agrees the valuation now. Shares are issued immediately, everybody knows their percentage, and the dilution is visible on day one. It takes longer to negotiate and requires more documentation.

For a first cheque into a very early Nigerian company, a SAFE or a note avoids a valuation argument neither side can win. For anything substantial, a priced round removes the uncertainty about what everybody actually owns.

Deferring valuation defers the argument rather than resolving it, and stacked notes with different caps produce a complicated conversion nobody modelled.

Maturity is a real risk. A note that falls due in a company without cash puts the investor in the position of a creditor of a company that cannot pay, which is bad for both sides.

The discount and cap can also take more equity than expected, particularly where the next round prices well above the cap.

And until conversion the investor has no shareholder rights, so they cannot vote, cannot receive dividends and are not on the register, which some investors find uncomfortable.