In the previous post I discussed the convertible note cap table and how we use this tool to price our convertible note offerings. The cap table provides an easy reference for calculating the cash return on investment that a company will receive from selling its note. This calculation can be complicated if the company is experiencing substantial difficulty in selling the note. In this post we are going to take a look at why using the cap table can help the company determine the correct cash return on investment for each of its notes.

In order to use the convertible note cap table correctly, it is critical that you have access to information about the valuation of the company's convertible notes. Many novice founders and note investors fail to do this and as a result they are greatly undervaluing their companies. In addition, many experienced convertible note investors often make the mistake of chasing after low trading prices. As a result, they do not receive the full amount that they could from their transactions. In this article I will show why using the cap table is so important when valuing the convertible notes of companies.

startups and inexperienced convertible note investors fail to realize the importance of obtaining information from their founders. Often these entrepreneurs lack the expertise necessary to successfully perform due diligence on their companies. The two best sources of information that I have found are the company founders network and the convertible note exchange.

The convertible note exchange is a database maintained by independent firms that provide pricing information for all types of note transactions. As the name implies, the exchange allows us to "buy out" a note by selling either one of the underlying assets or accrued interest. We can buy out a note by paying either less than the current market price for the note, less than the total value of the accrued interest plus fees, or a percentage of the total face value. The company with the most accumulated capital when we complete the transaction is the seller. This is how we determine our investment return and breakouts.

The company founders network is a subset of their private network of entrepreneurs that focus on early-stage companies. This subset communicates regularly with one another on strategies and opportunities that present themselves with the convertible notes of these companies. I have personally found this network to be extremely valuable in helping me complete my due diligence activities and obtaining investment opinions. The next time you find yourself with an opportunity that presents with a convertible note or any other asset, make sure to contact the next round of the network.

The convertible note exchange provides investors with pricing information on the underlying notes. This is information that can make the difference between securing your notes and losing them. This information is available to you in the form of quotes. Quotes are provided for the entire life of the note as well as for a number of days prior to the sale of the underlying note.

One quote is not necessarily better than another quote. Your return on investment should include all costs related to your conversion of the convertible note into cash. You will also want to consider the timing of your conversion. If you have not completed your due diligence activities on the business or if the funding sources for your business are insufficient, you may be able to reduce your costs by waiting until the business becomes more profitable. You may also want to wait and obtain additional financing during the startup of your new business.

Remember to review the conversion options offered to you on your convertible notes. Be sure to discuss the rate of return, lock-up periods, conversion into cash, and premium. These terms are critical to the success of your investment. In order for your convertible note to be funded, it must meet your cap and dollar roll criteria. By doing your homework on capital structure and evaluating investment opportunities, you will increase your chance for success.