What are the terms of Yuri Milner/SV Angel’s Start Fund $150K investment into Y Combinator companies?

January 31, 2011

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.

Comments

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  • Max

    Do Yuri and SV have the ability to block a sale of these companies?

  • http://www.startupcompanylawyer.com Yokum

    @Max – No.

  • Max

    What's the protective provision about merger/asset sale about?

  • http://www.startupcompanylawyer.com Yokum

    @Max – that's for the Series AA. If the note converts into Series AA at the investor option upon maturity, then you can't sell the company without majority Series AA approval.

  • Max

    So once it converts to Series AA, Yuri and SV can block the sale? Or there will be other Series AA investors, and Yuri and SV may not make up the majority at that point?

    (Sorry if I'm dense here. Great summary.)

  • http://www.startupcompanylawyer.com Yokum

    @Max – I don't think it is very likely that the Start Fund would ever convert in the Series AA. If there are problems with the company, it is better to be debt rather than equity from a bankruptcy perspective. There are already provisions to deal with a sale of company or IPO before a round of financing.

    If the debt is converted to Series AA, then the holders of the Series AA would have a block on a sale of company. In that situation, I don't think that there would be any other holders of Series AA — unless other convertible debt existed that had similar conversion into Series AA provisions.

  • http://www.seravia.com/ Casper Johansen

    Any chance the Start Fund documents will be made publicly available like the Y Combinator Series AA docs?

  • http://about.me/chrisco chrisco

    I wonder if/when Paul G of YC will get around to releasing the model convertible note he said he would publish here http://news.ycombinator.com/it

    I don't see how it would hurt any of the parties involved, except possibly attorneys, who might take a hit to their unit billings, hopefully offset by a bump to their unit shipments.