Convertible debt (also known as a "convertible loan" or "convertible note") is a type of loan that converts to investor equity. For example, an investor might agree to lend you money to start your business. But then, instead of making cash payments on this loan, you'd pay the investor back in the form of an ownership stake in your company.
When does that conversion from loan to equity happen? It happens when a future event occurs, and you and your investor will agree beforehand on what that event is. Typical examples are securing a second round of funding or reaching a certain level of profitability.
Because the agreement begins as a loan, it involves an interest calculation, and this interest causes the lender's investment value to grow month by month. At the end of the loan, the investor's financial stake will be larger than the loan's original amount.
To represent convertible debt in LivePlan, you'll need two entries:
- A special Loan entry representing the initial loan
- An Investment entry representing when the loan converts to equity
You'll also need to decide which month of your forecast you predict this conversion will happen.
Entry #1: Initial Loan
- In the Forecast section, click Financing:
- Click the Add Other button:
- Give the loan a name. Click Next:
- Enter the interest percentage for the loan, then click the button to indicate whether this loan will convert to equity within 12 months or in a longer time frame. Click Next:
Note: If you convert this loan to equity within 12 months, it's considered short-term debt in your financial statements. For more details, see What is the difference between short-term debt and long-term debt?.
- In the next overlay, enter the amount you'll receive for the loan in the month (or months) you'll receive the money. Click Next:
- In the last overlay, locate the month you predict the loan will be converted to equity. Enter the original amount of the loan plus interest in this month. Click Save & Close:
Note: If you aren't sure what the total interest amount will be, LivePlan can calculate that. First, enter the original loan amount in this step as a starting point to find the total interest. Then, after you save and close the entry, you can look at the Financing table's Balance line (shown below), scrolling to the month when you'll convert the loan. The total interest amount as of that month will be shown there. You can edit this loan entry to add the interest amount to your payment with that number.
- You'll now see the loan in the Financing table. The Balance will increase month by month as the interest is applied:
Entry #2: Conversion to equity
Note: Remember the month in which you entered the full payment of the loan entry above and the total payment amount, including the interest. You'll need that information for this entry.
- In the Forecast tab, click Financing:
- Click the Add investment button:
- Give the investment a name, and select One-time amount:
- Enter the full amount of the original loan plus interest. Select the same month you represented the loan entry being paid in full. Click Save & Close:
- In the Financing table, you'll see the loan balance changing to zero in the same month the investment occurs. This represents the debt converting to equity: