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Loan Lesson

Is convertible debt the way to go?

This story appears in the September 2006 issue of Entrepreneur. Subscribe »

Question: I'm trying to raise money to start a business, but I'm confused about valuation. How am I supposed to know how much of the company to give away to investors when I have no idea how much my business is even worth?

Answer: Determining the value of a startup without revenue, profits or product is never easy. That's why many early stage companies bypass the VC route and choose to raise money through convertible debt, a type of loan that pays investors a fixed annual interest rate (say, 8 percent to 10 percent) and also gives them the opportunity to convert their debt to shares of the company's stock at an agreed-upon price when and if the company gets acquired or goes public. Investors also get downside protection if the business fails and the company defaults.

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