(Note: Any numbers below are hypothetical and for illustrative purposes only.)

UPDATE: In italics below…

About to have a call with our lawyer about our convertible debt round. Some of the questions we’re going to bring up. With permission I’ll post some of the discussion after the call…

#1 - What should the payment be if there is a liquidity event (e.g., sale of the company) during the term of the note? Currently, it’s 120% of the value of the note. We feel that’s probably low. One of our investors suggests 200% in the first 12 months, 300% in the next 12 months, etc. with a cap of 40% of the sale price (if we sold we’d receive at least 60% of the sale price). Is this fair?

We’re going to go with 200% and no cap. Seems pretty fair…

#2 - After the term of the note what happens? Currently our note expires after 1 year. If we haven’t raised a Series A then what do we do? The note would be due and so legally we’d be obligated to repay our investors would own the company in its entirety. However, they probably wouldn’t want that as we as the entrepreneur would have little incentive to continue. Our thought is that the fairest thing to do would be to allow the debt to convert to equity at an agreed-upon valuation. Another possibility would be to convert the note into a new note (presumably with an additional discount going forward).

It seems best to just have this be a conversation/negotiation if it gets to that point. Ultimately we want investors we can trust and who can trust us. If we don’t feel comfortable that we can work something out in 12 months if things don’t go as planned then it’s probably a pretty good sign we’re talking to the wrong types of investors.

#3 - Do we convertible investors the opportunity to “ride along” for future financings? The ability to re-up in future rounds would definitely benefit the early investors. So if someone invests $100K in the seed/convertible round and ends up with 2% of the company at the time of Series A (a post-money of $5MM) do we give them the opportunity to “double down” and invest another $100K at the time of the Series A closing so they would own 4%. Good for the investor, potentially not so good for us especially as it relates to our overall ownership of the company.

Also, even more favorable for the investor would be the opportunity to take any “double down” opps that other seed investors don’t take. For instance, Investor A above doubles down and invests another $100K for an additional 2% of the company. However, Investor B (who has also invested $100K) can’t afford to or doesn’t want to. Can Investor A invest another $100K and end up with 6% of the company?

The feedback we received is that adding these terms would be fairly non-standard and could cause some hitches in our Series A financing. Anything that makes a Series A more difficult ultimately harms our seed investors and so while in some ways this is favorable to the earlier investors we think it’s best to leave these terms out. To the extent that we can give our seed investors the opportunity to raise their stake in Series A and future financings we would love to give them that opportunity. However, to give them that right definitely lessens our flexibility.

#4 - What exactly determines a Series A financing? We’ve set a minimum amount which determines whether an equity financing qualifies as “Series A.” What is a fair number? Certainly many Series A financings for web companies are smaller these days because the costs of creating a web business are lower. Also, is there an intention that Series A mean institutional money? If we banded five angels together who put in $500K each would that be our Series A round. Might seem like it is but at the same time the terms the angels agree to could be very different than the terms of a typical VC term sheet. So it’s not just amount that matters but also who’s investing.

In the end this could be pretty complex. So we’re just going to go ahead and say as long as the aggregate amount of the Series A is greater than $1.5 million it qualifies as a Series A financing.

That’s all for now. Update coming soon…

I’ve done some work with an amazing customer experience consulting firm in NY called Creative Good. Traditional usability testing measures things like “time to complete task”, and requires people to do things they would never do themselves. Creative Good’s method, on the other hand, involves setting a natural context for a customer by figuring out what kinds of tasks they perform on a given website, and then observing them performing those tasks. The results are more natural, because ideally you get a customer behaving as close to how they behave “in the wild” (a.k.a. sitting at home in their underwear.) From those observations, the one or two strategic issues, along with several tactical ones, become clear.

So I used a slight variation of this method today while observing our first set of customers “in the wild” (they were wearing pants.) We’d talked to quite a few customers in our ideal market already, but since people are notoriously bad at telliig you what they want, there’s nothing quite like watching your customers do their thing. It never ceases to amaze me how much I learn from sitting back and observing customers, and how few people do it. Perhaps it is pride (”I know what my customers want”), or shame (”I should know what my customers want”), or even fear (”Holy shit, I have to hang out with my customers?!”)… whatever it is, it is worth getting over so you can sit some customers down and watch them use your product.

Today’s session gave us some really good clarity, and we’ve got more coming up to further refine what we’re doing right and what we need to change before launch.

So we’re in the process of looking for good Rails developers these days. The first question I guess is “Why Rails?” Well, there are a lot of reasons and I think that Kareem could answer more of the technical side of the question but I’ll take a shot at the other side:

#1 - We love working with passionate people. In fact, those are about the only types of people we want to work with. You know, the types of people who are mad to live, mad to talk, mad to be saved…to quote Kerouac. Most Rails devs are like that. Mad to develop in Rails. These are people we want on board EduRev.

#2 - We’re skating to where the puck is going. You know the old Wayne Gretzky reason for being the best player in hockey (he skates to where the puck is going vs. most other hockey players skating to where the puck is). That’s how Rails seems these days. It seems so many of the cutting-edge developers are gravitating there. So while it might be a little tougher now to find solid Rails devs it should be a lot easier in the future as more talented and experience techies take it up.

#3 - We want to Get Real. We love the whole mentality behind the 37 Signals apps and fully intend to build our apps in much the same fashion. Rails devs are often Getting Real devotees. That’s exactly what we’re looking for. Hence Rails is a great choice.

So now on to finding devs. We’ve looked a number of places. Posted to sites like RubyNow. Contacted a bunch of people on WorkingWithRails. Pinged a lot of our friends, colleagues and even stood up on a table in a college cafeteria and shouted “Hey, can anyone here code in Ruby?” OK, maybe not the last part but we done a lot.

Bottom line? It’s really easy and really tough to find developers. On one hand it’s easier than ever. WWR lists over 7,000 Rails devs and that’s only a fraction of all the people that are out there. No doubt there are a lot of skilled folks out there. The key? Knowing what you want. I think about where we started and where we are now and we’re much more clear about who we want our devs to be.

What we’ve learned…

#1 - No dev shops. Talked a lot of them. A lot of really good ones. Ultimately it’s not the right fit. We want people who are willing to go contract-to-hire and then eventually join the team full-time. Dev shops aren’t a great fit for that. Plus…

#2 - We want dudes who’ll work for equity. Not all equity. Devs don’t produce if they are starving. Rather, we’re looking for people who are willing to take a major portion of comp in equity. Why? Contextual alignment. We’ll blog more about this later but ultimately we want devs who will share huge in our upside but also bear at least a little of the risk we’re taking.

#3 - Track record matters. We’re going to talk to the people you’ve worked with in the past. We’re going to check out the sites you’ve done and ask you what specifically you did on them. We want to know that you have a background that demonstrates that you can build really cool shit. This seems obvious. I think the reason to bring it up though is that we’re getting better at asking the right questions to determine if a dev is right for us (I’ll let Reemer fill you in sometime on what some of those questions are).

End of the day and we’re getting close. Not there yet. Still have a ton to learn here. But I feel that I’ve learned a lot more about finding good development talent in the last few months. If you have any lessons you’ve learned please feel free to add them in the comments. Back to work…

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

So Kareem and I made a decision today to start blogging openly about how we are creating Education Revolution. We’re not going to blog everything because (a) that’s impossible and (b) that’s not prudent especially in terms of respecting other peoples’ privacy and the fiduciary responsbility we have to our (soon-to-be) investors. Having said that we’re looking forward to giving you a much more transparent look into what we’re doing that 99.9% of the companies. We have two reasons for doing this:

#1 - To teach. This is our unselfish reason. We want to give back to other entrepreneurs around us and those who will come after us. We’ve been inspired and educated by stuff like Ryan Carson’s blog posts on the 37Signals blog, books like Founders at Work and movies like Startup.com. We want to do our part to give back. To make it easier for future generations of entrepreneurs.

#2 - To get PR. This is our selfish reason. In the interest of transparency we have to tell you. After all, most people wouldn’t but you’d know anyway that it was one of our reasons and so why not be upfront? We’re launching a site in a bit and we’d love to build some buzz for it. We figure this is a good way to do it.

What to expect? Well this won’t be Justin.tv or anything. Although that would be cool… Instead we’re just hoping to pop on here as frequently as we can and share our world with you. Hopefully you’ll learn from both the things we do right and more importantly, the things we do wrong. We’ll share a bunch. You tell us what you want more of. It’s gonna be fun.

But first, a couple of ground rules:

1. We’re not going to share anything about anybody else without their permission. That’s important to us. And it’ll probably be a little challenging to achieve. But we’ll do our best. And on that note don’t be surprised if you get an e-mail from us asking if we can blog about any conversations with you on our site. Think of it as your way to give back to future generations of entrepreneurs! Or just tell us no…

2. We’re going to share a lot about our business but not everything and probably a little less in the early stages. Right now a lot of our business value is IP-related (in terms of the concept). Over time we’ll share more and more but right now we’ll have to keep that a bit under wraps. We’re sure you understand. We are looking to share a lot with you about other stuff we’re doing right now including fundraising, formation issues, hiring people, etc.

This is kind of exciting because I really know whether this is the start of something big or a huge mistake (or neither :)). Regardless, it should be a lot of fun. Stay tuned…