Comments on: Should a startup company raise its seed round using a convertible note or Series A Preferred Stock?

By: Basil Peters

Basil Peters — Sun, 13 Jul 2008 02:04:34 +0000

I agree that a convertible note is preferrable to a preferred share, but there is an even better way. The convertible note structure is never fair to the angel investors. A much better structure, that retains the benefits, but has none of the disadvantages is the exchangeable share. I outline the benefits and the mechanics at http://www.angelblog.net. I hope this is helpful. Basil

By: Charlie

Charlie — Thu, 24 Apr 2008 00:42:25 +0000

In my opinion, a convertible note that converts at the lesser of (a) an agreed pre-money valuation or (b) [an agreed discount to] the next round price works well for both the company/founders and the investor. From the investor’s perspective it both caps the conversion valuation (a primpary objection to convertible notes) and lets the investor piggyback on the negotation power of larger investors in a valued round. From the company’s perspective, it allows it to raise capital quickly and cheaply. Even a “stripped down” Series A (i.e. no reg. rights, limited reps and warranties in the stock purchase agreement, etc.) can cost $15k -$20k or more in legal fees. If the convertible note also lets the investor convert to equity (probably common stock) before a sale and at maturity at an agreed upon valuation, it seems the best of all world for investors. But, in my experience many angel investors (at least in Seattle) seem to have a knee-jerk negative reaction to convertible notes (probably because they assume valuation cannot be capped) so it’s a more difficult sell for the founders than equity.

By: Logoworks Small Business & Home Business Newsletter » Blog Archive » Introduction to Startup Funding

Tue, 01 Apr 2008 17:11:45 +0000

[...] seed financing deals is convertible debt. At least that’s the current trend. I’ll let others (more knowledgeable in this stuff) explain convertible [...]

By: Cheryl's Desk

Cheryl's Desk — Mon, 11 Feb 2008 04:57:07 +0000

I would not use a convertible note as my first choice of financing. As mentioned above the debt investors are not interested in seeing the value of the company increase. Getting them to place a cap on their value in the Series A is not something any smart investor would agree to. Your best bet is to get an investor to accept a valuation for shares and have them work with you to help increase the value of the company.

By: Entrepreneurship from the Rock and Beyond » Blog Archive » Should I raise debt or equity for my seed round?

Wed, 12 Dec 2007 14:53:03 +0000

[...] Yokum Taku: [...]

By: An Introductory Guide to Startup Funding : Instigator Blog

An Introductory Guide to Startup Funding : Instigator Blog — Wed, 17 Oct 2007 14:04:08 +0000

[...] deals is convertible debt. At least that’s the current trend. I’ll let others (more knowledgeable in this stuff) explain convertible [...]

By: Venture Hacks — [Hack] Make your debt attractive to investors

Venture Hacks — [Hack] Make your debt attractive to investors — Mon, 18 Jun 2007 04:30:58 +0000

[...] Set a maximum conversion price for the debt. The debt could convert at the lesser of (1) $X/share and (2) the actual Series A share price. This cap effectively sets a maximum valuation for your debt investors and protects them from a high Series A share price. This is a great way to maintain the benefits of convertible debt while rewarding your debt investors for investing early. The maximum conversion price can be significantly higher than any valuation you could negotiate easily. [...]

By: Yokum

Yokum — Sun, 13 May 2007 02:48:47 +0000

I’ve never seen a conversion price written as the lesser of (1) [insert pre-negotiated valuation]/[fully-diluted shares at Qualified Equity Financing], or (2) the price per share in the Qualified Equity Financing. That doesn’t mean it can’t be done. I suppose this would eliminate the incentive of the investor to drive the eventual Series A valuation down. The primary problem will be determining the pre-negotiated valuation. The point of the convertible note is to avoid the valuation discussion at the time the note is issued. I think that the hassle of determining the pre-negotiated valuation is greater than the investor incentive issue.

By: Nivi

Nivi — Fri, 11 May 2007 01:15:30 +0000

Yokum, I meant that the debt investor would pay the lesser of (1) the cap and (2) the actual Series A share price.

By: Venture Hacks — Should you raise debt or equity?

Venture Hacks — Should you raise debt or equity? — Tue, 01 May 2007 09:16:09 +0000

[...] often raise their seed round by selling convertible debt instead of equity because debt is simpler and cheaper. Read Yokum Takuâ€™s excellent series on [...]