Many seed investment rounds in Southeast Asia complete using convertible note instruments like the 500 Startups Keep-It-Simple-Security (KISS).  These are unsecured debt instruments that convert to equity when a company completes its next equity raising.

In this guide we cover the 8 key features you should know when working with a KISS convertible note. From our experience, the KISS is the most common type of convertible note used in Southeast Asia.  If you are contemplating a seed round, we suggest you upskill on this document by downloading a version of the KISS adapted for Southeast Asia from our website.

There are other forms of note in use in Southeast Asia, including US style documents.  With these documents, US specific provisions need to be amended, e.g. removing US securities law and taxation language which shouldn’t be relevant for a non-US issuer.

an overview of how convertible notes work

Convertible notes anticipate that the investment amount is drawn down either in a lump sum on one date or, more likely, over a period of time.  The investment amount typically automatically converts to equity on the date of a qualifying capital raise at a discounted price to the next round price, but subject to an overall valuation cap.

If not already converted, the debt may be repayable (potentially at a multiple of the outstanding amount) or convertible at the noteholder’s discretion:

key features of convertible notes in southeast asia

Investment Amount The amount to be invested by the investor (noteholders)
Series Notes of a particular series are issued on the same terms. Typically, you may have a period of time to issue further notes on the same terms without seeking the consent of existing noteholders. The total investment amount is sometimes drawn down in a lump sum on one date or over a period of time with multiple closings
Interest This is the annual rate at which interest accrues on the note whilst it is outstanding. In Southeast Asia, the rate varies, but usually is a low amount, e.g., 1% or 2%
Maturity Date This is the date on which the debt is due for repayment. This should be a reasonable period of time from the date of the note, so that the company can achieve the qualifying capital raise (see below) to trigger conversion.  In Southeast Asia, periods to maturity are generally set at 18 months and can be longer.  Usually, if the company is unable to raise money before maturity, the majority of noteholders can elect for the debt to convert to shares rather than demanding repayment
Qualifying Amount The investment amount of the notes will automatically convert into shares at the time of the company’s next capital raise.  There is normally a minimum amount that must be raised to trigger conversion (called a qualifying capital raise), which is set to ensure that the raise is a legitimate company financing, not a device to trigger conversion
Discount Assuming the company’s next financing round is a qualifying financing, the notes will automatically convert into shares often at a discount to the share price paid in that financing.  The discount is intended to compensate investors for the risk they take on by investing at an early stage.  In Southeast Asia, this discount is typically 15-25%.  This follows Silicon Valley norms
Valuation Cap This addresses an initial concern that investors had with the KISS style and other convertible notes – that the company’s valuation could increase significantly and they would only have the protection of the discount to the price of the next funding round.  The valuation cap effectively caps the price at which investors pay for their shares when the note converts.  If your company raises a financing round at a $5 million pre-financing valuation but the convertible notes have a $2 million valuation cap, your note holders will effectively receive a 60% discount to the price that the new investors are paying.  So consider a valuation cap carefully as it can have a significant dilutive effect on the next round of financing if set too low
Majority-in-Interest This term simply means those noteholders holding a majority of the total investment amount of the series.  It is useful to incorporate this concept into the document so that key decisions are taken, or rights waived, not by individual investors but on a majority rules basis

Interested in learning more about the mechanics of the convertible note, or have a term sheet that you want us to take a look at? Get in touch.