Convertible Debt Intricacies
So we’re raising our angel round of financing. We decided to go the convertible debt route. There were a few reasons for that decision:
1. We like the opportunity to pull down money when we need it. With traditional equity rounds you wait until you get a bunch of money in, then you start spending. It seemed to us that it makes more sense in this low-cost, fluid atmosphere to be able to raise money on a more ad hoc basis. Not paycheck to paycheck (hopefully!) but rather enough capital to give us a decent runway while not having too much that we start spending it on stupid shit.
2. We like that our convertible note holders will get equity at the same terms as our Series A investors. We were originally going to do a common equity round. However one of the challenges is that the common shareholders won’t likely have the same rights as the Series A investors (who would likely get Preferred Stock with different liquidity preferences, anti-dilution provisions, etc.).
3. We like being able to reward early investors without having to value the business at this stage. Ultimately early-stage investing is a crapshoot valuation-wise. Some early-stage companies raise money at a too-low valuation (I have a friend who raised money at an initial pre of 100K for what I think is going to be killer start-up). Others go out at a valuation that’s much too rich which almost always forces a “down round” and leaves everyone with a bad taste in their mouth. Be delaying the valuation decision until the Series A we’ll have a lot more data on which to base a valuation. We think that’s a good thing.
We’re still working through our convertible terms. However, for now it’s something like this:
-3% per month discount capped at 36% discount after 12 months
-8% interest rate
-convert to equity at Series A terms and valuation
Legal note: This isn’t a solicitation for funding. We’re just sharing information about how we’re doing our private fundraising.
We patterned our raise after the Charles River QuickStart funding program. The increase in discount each month is a bit non-standard but we feel it adequately mirrors the risk-reward profile of early stage investing without forcing a valuation discussion.
The biggest issue that we’ve faced is there’s the question of what to do at the end of 12 months if we don’t raise a Series A round. We’re looking at a few options and will share more on that later. The other thing that’s a bit of a concern is not having entrepreneur and investor interests totally aligned. For example, while our investors of course want to see us succeed if we have too high of a valuation at the Series A then their relative stake in the company is smaller even if the promise of a good return on their money is stronger. So we’re looking at some ways to bring those interests more in alignment as well.
Will post a lot more on convertible later but this is a good start.
Update: (Kareem here) Here’s a Google spreadsheet that shows the difference over time between a discount and a premium. CRV’s Quickstart site has more, and you can download an Excel spreadsheet to play with, here:
Discount Versus Premium Spreadsheet
