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Could your new healthcare business benefit from convertible debt

Deanna Pogorelc on February 23, 2012

When a healthcare startup wants to raise money but doesn’t yet know the company's value, convertible debt is a likely alternative to selling equity.

But what does that mean? Convertible debt essentially provides a startup with operating capital via a loan from an investor that will later convert to equity in the company after a certain trigger event, usually a round of funding.

Instead of making an early-stage investor decide the value of the company -- an uncertain process, especially for a pre-revenue company -- convertible debt allows the investor to offer a loan until another investor can come along and price the company. Once that newer investor decides the value of the company, the original investor’s loan converts to equity at that valuation, except with a discount that is decided upon at the original investment.

With the discount, the original investor will get more shares of the company, providing him or her with a reward for taking the risk and making that early-stage investment. But, convertible debt investment could cause dissonance between an entrepreneur and the early investor, who wants to own the largest possible share of a company and may push for a lower valuation than what the entrepreneur wants.

To learn more about what convertible debt investment is and see how it works, watch this video from USparkFoundry.

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