Financing Options: Convertible Debt
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Re: Financing Options: Convertible Debt
#2Great post and I'm also not a fan of convertible debt, but for different reasons: As an entrepreneur I don't like the idea of carrying a chunk of debt on the balance sheet at an early stage. I also don't like the assumption of either another funding round or an exit hanging over the company.
Re: Financing Options: Convertible Debt
#3As an entrepreneur, I love early-stage convertible notes for at least two reasons. The simple and lesser reason is that it's a lot cheaper -- $0-10k in legal costs to raise $1.5mm or so in notes, vs. $50-100k for an equity A round.
The really big advantage of notes, especially START-fund style "we'll defer even pricing the note" notes, is that it reduces the number of things an early stage team needs to think/worry/stress about.
Creating a new business is inherently chaotic and stressful. Nothing is nailed down, and some decisions are lasting. I'm no better than top lawyers or salespeople at negotiating terms, and I'd rather not burn my resources on trying to win in a potentially adversarial negotiation with investors over price and other terms early on -- focus should be 100% on product, sales to early customers, and team building.
Any investor who won't let me avoid the hassle of pricing a round, paying lawyers a bunch of money, etc., can sit and do whatever it is VCs and angels do with their spare time for a while until there's enough traction and revenue to justify raising yet more money, hire someone to handle sales and development, and then founders can focus on negotiations with pricing and terms.
Of course, an investor who waits like that is going to end up paying a much higher price for the same amount of equity, since some risk will have been eliminated, other investors will be interested, and money will be less value-add (in a seed round who provides the money matters more than the terms or amount; as the venture grows, terms and valuation matter more and more, culminating in bridge/mezz or IPO where the terms are all that matter.
Re: Financing Options: Convertible Debt
#4As an entrepreneur, I love early-stage convertible notes for at least two reasons. The simple and lesser reason is that it's a lot cheaper -- $0-10k in legal costs to raise $1.5mm or so in notes, vs. $50-100k for an equity A round. The really big advantage of notes, especially START-fund style "we'll defer even pricing the note" notes, is that it reduces the number of things an early stage team needs to think/worry/s…
In your example of 'an investor who waits like that is going to end up paying a much higher price', the visionary investors who said yes to the convertible note will get a very similar price (20% discount?) for taking all that risk.
Put yourself in an investors shoes: Which round would you want to invest in? Wait and see all the progress and pay 20% more or invest early and in a great scenario pay 20% less or in a worse case scenario see it go nowhere?
Re: Financing Options: Convertible Debt
#5As an entrepreneur, I love early-stage convertible notes for at least two reasons. The simple and lesser reason is that it's a lot cheaper -- $0-10k in legal costs to raise $1.5mm or so in notes, vs. $50-100k for an equity A round. The really big advantage of notes, especially START-fund style "we'll defer even pricing the note" notes, is that it reduces the number of things an early stage team needs to think/worry/s…
In your example of 'an investor who waits like that is going to end up paying a much higher price', the visionary investors who said yes to the convertible note will get a very similar price (20% discount?) for taking all that risk. Put yourself in an investors shoes: Which round would you want to invest in? Wait and see all the progress and pay 20% more or invest early and in a great scenario pay 20% less or in a wo…
If you're not a top top tier investor, you won't even get in in a successful company's A round at the market price. Especially if you're looking to invest $10-25k. Why should someone bother taking ~10 x $15-100k from random people when KPCB or Sequoia would be happier if they could add an extra $1mm to their investment to bump themselves up 5-10% percent in ownership?
If you approach a company with which you have some connection early on (especially as an angel, especially in the same domain you are an expert, especially if you know the founders), you might be able to get in by offering favorable, no-hassle note terms early on.
Steve Jobs can always buy at the market price (or even at a discount), but even though I narrowly qualify as an accredited investor, there is no chance I'd get into a hot deal for $15k myself once it's at the A round stage.
Re: Financing Options: Convertible Debt
#6Great post and I'm also not a fan of convertible debt, but for different reasons: As an entrepreneur I don't like the idea of carrying a chunk of debt on the balance sheet at an early stage. I also don't like the assumption of either another funding round or an exit hanging over the company.
True, there are some negatives for entrepreneurs to use convertible notes. It all comes down to what you're comfortable with and what the investors you want to have are comfortable with. I'd much rather have someone like Fred Wilson invest in priced equity than get convertible debt from an investor who's less experienced, helpful, and connected.
Re: Financing Options: Convertible Debt
#7Convertible notes are a show-stopper for me in the early stage of a company, because it's an all or nothing bet.
Let me explain: a zillion things can go wrong in a startup. You might not identify a scalable business model within 1-2 years, or you might not find the best way to monetize your assets. You might reach in 1-2 years just ramen profitability, with the rest of your work tied up in non-liquid assets (like non-monetized-yet code). The third year might be the one where you go crazy and manage to scale your business.
But, here's the catch: a convertable note is debt; if you don't manage to raise VC money or angel funds, which is even more probable if you're not located in Silicon Valley, if you don't have connections, a track record or if something goes wrong in your startup, that convertible note which you carelessly signed 2 years ago comes to maturity. You're expected to pay $150'000 or whatever out of nothing when you've just reached ramen profitability. If the investor is an ass, he's now your creditor and can ask your bankrupcy (and get the intellectual property, the domain name and all the code of your startup without you being able to do a thing).
So in respect to convertible notes: thanks but no thanks.