On January 28, 2011, Yuri Milner and SV Angel announced that their Start Fund would offer all Y Combinator companies $150K in convertible debt. Reactions are mixed, from “no big deal,” to “disrupting angel investing” to “you’d be crazy not to take this deal” to “facilitating a bubble” to “strategic perfection.” TechCrunch reports that within 24 hours, 36 of the 43 companies had already signed the convertible debt documents.
I had a chance to review the terms of the convertible debt documents used in the transaction.
Below are the major points:
Interest rate: higher of 2% or AFR (applicable federal rate). (I think the intention to keep the interest rate as low as possible. In the past, interest rates on convertible debt seemed to be in the 7% to 10% range, but I recently saw a VC fund offer $500K of convertible debt at a 3% interest rate.)
Maturity date: two years or maturity date of other convertible notes. (This also seems to be fairly company favorable as most convertible debt seems to have a one year term.)
Automatic conversion: on a $1M equity financing with no conversion discount and no price cap, provided that the transaction documents provide for a right to purchase a pro rata share of future financings. (I don’t know how to get a better deal than this.)
Optional equity conversion: on other equity financings with no conversion discount and no price cap. (Once again, I don’t know how to get a better deal than this.)
Optional maturity conversion: into Series AA Preferred Stock based on a $5M valuation. The Series AA has a 1x non-participating liquidation preference, weighted-average anti-dilution, basic protective provisions (adverse changes to the Series AA, number of shares of Series AA, or merger/asset sale), right to maintain proportionate ownership, ROFR/Co-Sale rights and basic information rights. (Please note that these are generally the terms of the Series AA Preferred Stock financing documents that Y Combinator previously published.)
Optional change of control/IPO conversion: into common stock at the lesser of (A) fair market value (based on change of control or IPO), or (B) $5M valuation.
I can’t think a good reason to turn down this deal, unless a company is never planning to raise outside investment. Congratulations to the Y Combinator companies that are benefiting from these terms.
Update: In the second batch of YC companies, a “most favored nation” clause was added so that StartFund receives the benefit of terms negotiated by later convertible debt investors.