In an earlier article, we explained how a revenue sharing note works. This time, we’re focusing on term notes.
Term notes are similar to something most of us have experience with – car payments, home mortgages and student loans. The way term notes work on NextSeed is similar: a business agrees to pay investors the same amount every month until it’s paid off, including interest.
Let’s walk through an example of how this works:
The growing business
Say there’s a gym in town that everyone is raving about – Lickety Split. It’s got the best equipment, and it’s staffed with coaches who know how to motivate. The owners, Morgan and Alex, see that their customers are increasingly interested in yoga and Pilates workouts.
Morgan and Alex decided to scoop up the unit next door and turn it into a dedicated area for yoga and Pilates classes. They’re hiring a great team of instructors and renovating the space.
Why a business would choose a term note
Along with their own money, Morgan and Alex have decided to apply for a $100,000 loan on NextSeed to help complete their buildout. They’ve got a loyal following and want to invite everyone to share a piece of the pie. They also want to attract new customers to fill up the new spots that will open up after the expansion.
Offering a term note makes sense because Morgan and Alex have an established business that’s already generating consistent cash flow. What they want is certainty each month. With a term note, they will know exactly how much they need to pay investors every month. They may also choose to pay off the note early with no prepayment penalty if the expansion goes well (this means they only pay the outstanding principal left on the note and no additional interest).
Putting the offering together
NextSeed uses standardized metrics to evaluate the new business and proposes appropriate investment terms for Morgan and Alex to choose from. These are the terms that Morgan and Alex would offer to potential investors on NextSeed. They choose term notes with the following terms:
Interest rate: 18%
Maturity: 42 months
This means Lickety Split agrees to pay investors their principal investment plus an 18% annual interest rate for 42 months. Payments will start after the first full month following a successful closing.
NextSeed does its due diligence and background checks on the company and its owners. Morgan and Alex provide their financials, business plan and renderings of their new space. NextSeed helps them put together their offering page, and they’re ready to launch an offering for the expansion of Lickety Split.
The investment and payments
Imagine that Adam invested $1,000 into Lickety Split, and it successfully raises the $100,000 from investors. Construction has been ongoing and the newly renovated space is open for business soon after closing.
In a month or so, Adam gets an email saying “Hooray! You received a payment today” and it notifies him that he’s been paid $32.26!
Here’s how Adam’s payment was determined:
Adam invested $1,000 into Lickety Split, which agreed to pay him an 18% annual interest rate for 42 months. The note payments are amortized (like a mortgage), where each monthly payment is the same and contains a payment of interest and a payment of your principal. So in this example, Adam’s payment of $32.26 is about the same amount that he will receive every month until the entire principal is paid down.
Since the annual interest rate is 18%, the monthly interest rate is 1.5% (18%/12 months = 1.5%).
In month 1, Adam’s $1,000 investment is his starting principal. The interest on his investment is calculated by multiplying the monthly rate (1.5%) with the outstanding principal during that month. So in month 1, Adam’s interest is $15 (1.5% x $1,000 = $15). From the total payment of $32.26, $15 is his interest payment. The remaining $17.26 ($32.26 – $15 = $17.26) pays down Adam’s principal. After this payment, his outstanding principal investment decreases to $982.74 ($1,000 – $17.26 = $982.74).
In month 2, the same calculation takes place – this time with Adam’s new starting principal of $982.74.
Here’s a chart that shows how it works month after month:
Month Adam’s principal investment Total Payment that Adam gets Interest Payment (part of Total Payment) Principal Payment (part of Total Payment) Ending balance of Adam’s principal investment 1 $1,000 $32.26 $15 $17.26 $982.74 2 $982.74 $32.26 $14.74 $17.52 $965.22 3 $965.22 $32.27 $14.48 $17.79 $947.43
These payments are expected to continue until the business pays Adam in full after 42 months, or sooner if the business prepays the note.
Disclaimer: This example is for illustrative purposes only and does not reflect an actual deal or performance. The terms of each deal differ. Payments are not guaranteed or insured and investors may lose some or all of the principal invested if the business cannot make its payments.