Convertible Debt

Back in the summer of 2010, I wrote a post outlining why I don't like convertible debt investments. USV does a fair bit of seed investing and we have never done a convertible debt deal (although we have done bridge loans for our existing portfolio companies). My wife, aka Gotham Gal, does a fair bit of seed investing and she has done her share of convertible debt investments, always with a reasonable cap, but she also prefers a priced equity round.

Convertible debt is being discussed again, I suspect because valuations are coming down and that is causing some problems, but also because there are folks suggesting improvements on the structure of these deals.

My view on this is fairly simple:

1) A priced equity round can be done quickly and inexpensively. Most experienced venture lawyers have a standard form of "lightweight Seed" or "lightweight Series A" documents that can be signed without negotation on both sides. We do this all the time.

2) When you set the price, both sides know what deal they got. It's locked in and they are in business together and aligned. The entrepreneur can't get screwed later when the price drops on them. And the investors can't get screwed later when the price jumps on them. This is a big deal. I don't understand why folks don't understand it.

3) Equity is simple. You own what you own. Debt is complicated. All sorts of things can happen with it, including bad things.

Mark Suster has a long and winding but very good post on all of this on his blog. If you want a detailed discussion of this issue, go read it.

My hope is the market moves back to priced rounds for all things including seed and angel deals. It's a better, simpler, and massively less complicated way to do venture investing.

#VC & Technology

Comments (Archived):

  1. kidmercury

    suster’s post is way too long. i was offended by its length.over-expansion of debt/money is a hallmark of bubbles. now that goldman has run the pump and dump and moved on to other targets the party is over. back to straightforward equity deals.

    1. fredwilson

      #brokenrecordthat is not a diss. just an observation

      1. kidmercury

        i briefly considered changing my disqus name to brokenrecord, but for better or worse the identity is locked in at this point. perhaps on a future social network.

        1. ShanaC

          don’t you hate the idea of having a locked identity though?

          1. kidmercury

            to clarify disqus does let me change my name, but the identity is “locked” in that it would be kinda weird for people who have grown accustomed tor referring to me as kidmercury to all of sudden refer to me as brokenrecord. so, by way of customs and social norms, my identity is “locked.” i don’t see how this can be changed unless i simply deal with the transition difficulties and change my name. i think these social norms are good, though, so i don’t mind them and in fact value them.

          2. ShanaC

            oh, I know, I’m wondering if you are hating being trapped in social norms

      2. LE

        #brokenrecord.It’s brainwashing. And actually quite effective as a strategy in many situations especially if done correctly. The more familiar something is to you, the less likely you are to object to it as long as you don’t boomerang to total rejection. (Not something I’ve read although I’m sure the principle is out there) but something I’ve observed.

        1. Wavelengths

          “Tell ’em what yer gonna tell ’em. Tell ’em. Tell ’em what you told ’em.”Classic sales.

          1. LE

            “Classic sales.”As a matter of fact, in reverse, when Obama was speaking the other night I noted to my wife that he didn’t mention Romney by name. One time I believe only. Other time referred to the party or “my opponent”. Only time to do that would be if you are the clear underdog. Then you want to gain from the halo by comparison.Same reason IBM never mentioned the competition. Didn’t want to legitimize it. Afterwords the commentators picked up on this. But it served his purposed.This kinda discusses IBM but from a different angle:…It claims that talking negative boomerangs. IBM was the leader and I think it was more about legitimizing the competition. This is an art not a science.One of the things I would always ask salesman back when I was buying expensive equipment was to ask them who they competed with. That way I would find the other people that I should be talking to. The usual suspects. A smart salesman will dodge this question or provide misinformation.Let’s say Fred is doing a deal with a company that has no clue about the VC landscape. And they ask him a question to try to identify other VC’s that they should be speaking to (don’t assume everyone is clued in). Or they ask Paul Graham “who are the incubators that you admire”. (Could be the father of someone considering YC.) Any answer, in general, can legitimize competition and give them further interest. As always there are also reasons to not follow this strategy.

    2. William Mougayar

      True. I was too tired to leave a comment after reading it.

      1. PhilipSugar

        I think it’s sad I’ll watch people waste hours on twitter but they don’t have the mental discipline to read a post that is much shorter than most newspaper articles were. I thought it was a great post and not at all too long

        1. Luke Chamberlin

          How do you find the time to watch people waste hours on twitter?

          1. PhilipSugar

            Trade shows and travel

          2. kidmercury

            lol +1

          3. andyidsinga

            LOL – even though I agree with @philipsugar:disqus but he really goofed that argument 🙂

          4. PhilipSugar

            Zing pow!

        2. William Mougayar

          But you didn’t leave a comment either? The post wasn’t long by Suster’s standards. But the few good parts in it were washed by the long winded re-hashed  stuff, making it mentally un-stimulating for a comment. Yes, I find it sad that certain excellent authors (eg Suster, Dash) spend an unproportional amount of time on Twitter chatter and barely participate in the comments spaces of their own blogs. 

          1. LE

            “The post wasn’t long by Suster’s standards.”Now you’ve got me curious. I’m going to take a look and report back my findings.

          2. LE

            Just took a look. And using the unix utility “wc -w” seems that there are 3079 words in the post.Using this to determine typical page length:http://www.writersservices…….and using the word count of 400 words per page we come up with a post that is seven pages long in traditional print book size. Quick and dirty. (Anyone can feel free to check my math and assumptions and chime in of course).We could go further with this and see how many words per minute people read to find optimum size. I’m sure this has all been figured out already.The obvious solution would be for Mark to break this into multiple posts. 3 would work.

          3. William Mougayar

            Actually, 3000 words is pretty long for a blog. I think that seemed to be on the upper end of his typical blogs. I saw a few 1700 word ones recently.I typically like to read 500-800 word ones. Longer ones have to be extremely well written. Anil Dash’s blogs are long too, but are very well written.

          4. PhilipSugar

            I didn’t really have anything to add that might be the highest compliment.

          5. William Mougayar

            I felt the same way. Neutral action ending = no comments.

          6. Guest

            implied signal?

          7. William Mougayar

            Yeah. Indifference-as-a-Signal.Same initials as Infrastructure-as-a-Service 🙂

          8. PhilipSugar

            See I’m not sure the most comments equals best post. Fred gets the least on accounting (see last week) Mark gets the least on sales. Both are their best work.If you want the most comments, flame Obama or Romney. Is it a good post? No it sucks but it will get a bunch of comments.

        3. LE

          “have the mental discipline to read a post that is much shorter than most newspaper articles were”I think that depends on interest level.There are books that I have read, magazine articfles, and movies that I have seen which I call “want them to never end”. I wish there was more material because I enjoy it so much.But not everything falls into this category.Mark’s post would certainly be required for anyone who needs to understand and know that info and should then put aside a time to read and understand the entire article. Along with forking to find more about anything that needed to be clarified. But that’s not a wannabe reader who wants to either talk a good game or just has a casual interest.

      2. ErikSchwartz

        Which is ironic because comments are your business.

        1. William Mougayar

          Lol. Good point. Yes and No. My business is about online conversations & discussions, not just comments. I prefer to leave comments on blogs where the author is regularly engaged with the commenters or when I’m mentally stimulated to agree, disagree or expand on what’s being discussed. 

          1. LE

            “I’m mentally stimulated to agree, disagree or expand”Yeah did you ever notice that it is effortless in coming up with a reply if some emotion nerve is stimulated. Same reason starving artists make such good music (it’s in response to pain or pleasure) but have a harder time when they are successful.

          2. William Mougayar

            Yes. I agree.

          3. Wavelengths

            Notice how many people posted yesterday, both with pix and comments.Emotional stimulation all over the place. Total engagement.I’d like to take all of yesterday’s thread and frame it, piece by piece. Such fun.

      3. LE

        As I’ve mentioned before your “popular discussions” email is totally drawing me into to commenting elsewhere. I’m beginning to further understand addictions. I know it’s best to cancel those emails but somehow I can’t. Thank god I can at least type quickly.

        1. William Mougayar

          Yup. We’re all addicted to something.

          1. Wavelengths

            Well, some people are more prone to addiction than others. And there are many types of addictions.(I’m not looking for “AVC Anonymous” yet. 🙂

      4. andyidsinga

        I’m glad you took a break after reading that post and then came here to comment about it – hahahaha

        1. William Mougayar

          True. @philipsugar smoked me out!

        2. Abdallah Al-Hakim

          that is a very keen observation 🙂

    3. andyidsinga

      i DVd you dude (in a friendly way) – tl;dr is lame

  2. Peter Sullivan

    I think convertible debt is smart for friends and family rounds because it avoids the awkwardness of pricing a very very early stage company. Let more institutional investors price it later with a heavy discount. I also think CD is good in a period of a startups life when they are 3-9 months out of hitting a very important milestone but need some cash to get there before raising a much higher priced Series A. Your thoughts?

    1. fredwilson

      a 20% discount doesn’t give your friends and family sufficient return for the risk they tookgive them a good deal on the equitythey are your friends and family

      1. Peter Sullivan

        But as a web based company with nothing more than an idea and a team where would you expect entrepreneurs to begin. I think 20% is too little (as its standard practice for more sophisticated investors) but you don’t think a 30% discount is fair? To relatives it can feel like your throwing a dart to get your valuation, which for most companies is pretty realistic.

        1. fredwilson

          i would rather give them a valuation. put a million dollar valuation on the idea, raise $100k from them, and give them 10% of the business. simple, easy, sensible

          1. Peter Sullivan

            I think you make it seem easier than it is. We live in a bubble. A million dollar valuation for nothing other than a small team and an idea is hard for most to swallow.

          2. Hector

            … and that’s why convertible vs priced is a US-phenomenom, No “just ideas” are backed with one million dollar valuations in Old Europe. Nor hey should not be. But everyone should be clear on the risks and prices of those risks.

          3. Peter Sullivan

            Hector I started a company over in Europe and this is very true, and as a consequence for this risk adverse behavior you see a much less mature tech market. I would never attempt to build a tech company in Europe because of it.

          4. fredwilson

            it’s all option value. its not real value.

          5. Cam MacRae

            For a small team and an idea I like a valuation at approximates 18-24 months employment in their best alternative occupation given their skills and abilities and the current market conditions, plus a small carrot.For example, 1.5 years * 3 developers @ $100k pa. * 1.20 carrot = $540k.But as the bartender says, it’s all option value.

          6. ShanaC

            1.20 carrot?

          7. Cam MacRae

            As opposed to a stick.

          8. John Revay

            Depends – ideally they are advancing you the funds B/C they are your friends and family.Most start-ups fail… they will likely loose their money if it is a $1M val or $250K

          9. markslater

            its just not that easy to do.

          10. Wavelengths

            If the business idea isn’t worth at least $1M from the outset — at least to friends and family — is it even worth pursuing as a real business?I like your numbers. $100k should be enough to get the ball rolling and to then raise that valuation as the idea becomes real — real enough to attract further investment to grow the business more.Right?

          11. Hector

            Peter, Europe is laden with red-tape and risk-averse behaviors … even with laws preventing entrepreneurship: Granted, but not my point. 100K per @fredwilson:disqus could be enough to get it going, Regardless where you are. Could it not be priced at the outset?

          12. fredwilson


          13. John Revay

            If Equity for F & F…..( and not CD w/ a discount) then I very much like your simple, easy, sensible approach.

      2. John Revay

        HUMMMMM I am all screwed up now……I thought a little over a year ago you were suggesting that CD made sense for F & F seed round.”I would recommend doing friends and family financings as convertible notes with a discount and a cap on the valuation. That way you don’t have to worry about how to price the investment. A 20-25% discount from the next round is appropriate.”…

        1. fredwilson

          I guess I am contradicting myself. Friends and family rounds are most commonly done as notes as I mentioned last year. But the more I think about it the more I think friends and family deserve more than a 20-25% return into the next round for writing the first check

          1. markslater

            firstly – its very dangerous to take F and F money – i absolutely avoid it. I’d prefer they come in alongside the A. I’ve had many a friend ask to invest, and have gently told them that i’d prefer they lined up with an institution.unfortunately – early on, its most times the only source of capital so its a bit of a paradox.I’ve seen F and F go very ugly – very ugly.

          2. fredwilson

            Great point. I totally agree with the concerns. Dennis Crowley wouldn’t let his dad invest in foursquare

          3. markslater

            and yet my cap table has every single member of my family named on it…..thats how you treat your F & F

          4. markslater

            well in that case, poor dad 😉

          5. PhilipSugar

            Me too. Fortunately not firsthand, but I have seen some real ugliness. When you talk about “hair on a deal” I have seen some gorillas. Getting some crazy F&F calling you up as they are going to get a haircut when you bailout their deal. Want to talk about a deal killer?? I’ve seen that on a mass murder basis.

          6. John Revay

            I like where this post & thread is going….So in CT – the state has a quasi/gov VC fund – CI or CT Innovations. They have a program called “Pre-seed fund” They will essentially loan a company on a non recourse basis up to $150K, providing the company is able to raise and additional 50% or $75K.So – if I am able to convince some of my well healed friends to invest $75K for 7.5%. In the event of an equity round, CI has the option to convert its debt to equity at a 25% discount to the pricing of the equity round.

      3. markslater

        thats absolutely not correct. convertible instruments certainly do provide for a sufficient return.

        1. fredwilson

          A 20-25% stepup into the next round is a jokeIt ought to be 2-3x given the risk they took

          1. Wavelengths

            I thought one big reason to make money was to share it around.If I could give my parents a 2x or 3x return for risking just because they believed in me (because you know at that stage it’s not really about their evaluation of the business idea), then that’s not even enough, by my standards.Someone gives me $100k to start a business that becomes a $30M company in three years (not an impossibility with the right idea and strong guidance), then giving them a return of $300k doesn’t begin to show real gratitude.

      4. markslater

        that equity gets subordinated to your preferred all day. Wont you stick them down in the seller with all the other “commoners?”. Or would you allow those friends and family to take the same terms are you?

        1. fredwilson

          Same. They invested cash just like I did

          1. markslater

            fair enough – thats great. I’ve not seen that.

        2. fredwilson

          And I am not a big fan of layers of liquidity preference early on. Pari passu works fine for me in early stage deals. That changes in late stage rounds and M&A.

  3. Hector

    A true non-global issue but a local fad, anyone cares to review the number of deals made on convertible notes vs priced equity outside the US? Latter wins by a landslide.

    1. fredwilson

      that’s interesting

      1. Hector

        when you buy bread you don’t put a call for next day … it is priced and bought on the spot. Friends & Family who buy your “dream” must be rewarded for what they bought, when they bought it. They too share the overwhelming risks of losing their pants altogether. Time to get real!

        1. Matt A. Myers

          I’m not sure people who are professional VCs are taking the same kind of risk as friends and family who don’t have domain expertise.. A professional VC isn’t going to invest in something they don’t truly believe will work, or they’ll only invest what they’re comfortable losing and invest because of who the founder and/or team is.

          1. Hector

            Precisely, that’s why you have to put a price, Bear with me, Large Corps rely on VCs to bring mature deals to them (and save R&D inefficient money), VCs rely on angels or F&F to bring deals to them. There is a risk factor down the ladder. It all ought to be priced.

    2. kidmercury

      yup, because bubble 2.0, like its predecessor, was a US phenomenon. other parts of the world helped pay for it with higher food prices though.

    3. Luke Chamberlin

      Could be that laws in the US are more favorable to convertible debt.

      1. Hector

        Not quite, it is a matter of lesser liquidity so everyone wants to know what they bought, when they bought it. You share the risks of uprounds or downrounds, ie, price is set in the outset.

  4. Luke Chamberlin

    I have a hunch that convertible debt’s popularity was due in part to the trend of consumer internet startups that planned to get huge and then figure out how to make money with ads, or something. Putting a valuation on these startups was mostly hype and dice-rolling.Now that Facebook IPO has soured the markets for these sorts of consumer internet startups, and more startups have non-ad based revenue built in from a very early stage, marketplaces or direct sales and such, it will be easier for them to justify their valuations for equity rounds. It also means that those rounds will probably be smaller, as rounds based on reality often are.Just an observation, not sure if it holds water.

    1. fredwilson

      i don’t think so. many of the investments we’ve made and been successful with over the years are “startups that planned to get huge and figure out how to make money later” we have never had any difficulty negotiating a valuation with an entrepreneur on any of them

      1. Luke Chamberlin

        In general, isn’t it easier to put a valuation on a startup with revenue, or at least plans for revenue (i.e. 10% of marketplace sales)? Or does it not matter?

        1. fredwilson

          nope. early stage valuations aren’t really valuations. they are the exhaust fumes of a negotiation about two things – the amount raised and the amount of dilution

          1. ShanaC

            so why not call them that when it comes to investing?

          2. markslater

            and the onion peels – correct shana – its not that smart for an entrepreneur to price too early. Its what the VC wants – its not always what the entrepreneur should do though

          3. Hector

            How about if convertible debt is thought as a means to rapidly achieve traction and deploy resources (and focus teams’ time on value … and not in fund raising)? And not care so much on caps, rachets, postponed liquidity preferences and the likes.

          4. Brad Lindenberg

            That is very naive. You can’t ignore that stuff. You’ll get screwed down the track.

          5. Brad Lindenberg

            Pricing early hedges the entrepreneur against lower future valuations. I’d rather protect the downside especially if revenue models have not been figured out yet.

          6. fredwilson

            Call them what?

          7. ShanaC


          8. fredwilson

            i will try that. i will get some crazy looks.

          9. Luke Chamberlin

            That sounds like a really zen approach, since you’re implying valuation as you negotiate those two numbers. I’m trying to wrap my head around it.

          10. PhilipSugar

            That is a great comment especially if you combine the amount raised with how far that will get you in terms of time and traction

          11. fredwilson


          12. Brad Lindenberg

            Great comment Fred. I wish all investors thought this way…1) How much do you need?2) How much are you prepared to give away?= ValuationAt the end of the day the entrepreneur needs fuel in the tank AND **alignment** and the investor should be thinking long term enough to bypass the ticking time bomb that ratchets represent.Ratchets are short term poison for entrepreneurs.Why would an investors want to own 75% of a company anyway? It leaves little incentive for the entrepreneur to create value.

          13. pointsnfigures

            I look at as a life cycle. In general, on the first round the entrepreneur gives away 15-25% of their company. By the exit, they will only own 15-25% of the company. If they do their job right, initial valuation won’t matter that much-because owning a small amount of a 100M company is a lot better than owning 100% of a 4M company that should be pre-money priced at 2M

  5. William Mougayar

    Roger That.

  6. Seth Godin

    It’s worth distinguishing here that this makes sense for venture investing, but for the typical small business (without desire or path for an exit), certain kinds of debt make far more sense. If you’re buying an asset, for example, better to pay it off and then own it than to have to go through all the hoops of a minority investor.

    1. fredwilson

      yes, absolutely. financing an asset with debt is often a smart move, particularly if you can secure the debt with the asset and no personal guarantees

    2. ShanaC

      as more typical small businesses become internetized – what would be the best way to get money – debt?

  7. Pravin J

    In early 2006, Convertible Debt was projected as easy / hassle less way of raising early / bridge money till the time institutional round followed –…. Over years, more followed the trend, it got complicated.

    1. fredwilson

      projected being the operative wordjust because they tell you something doesn’t mean its true

      1. Pravin J

        right. guess the model took its time getting validated.

  8. Guest

    “both sides know what deal they got” – true. But that seems to me to miss the fundamental objection I have to ‘priced’ rounds, which is that early-stage companies (many of them with first time founders) generally have no idea what a ‘fair’ or market valuation is, and hence must rely on the investor to be upstanding. Let’s just say not all investors have the reputation for honesty you have.Also priced rounds have tended to create the need for a single entity to ‘lead’ the round with all the problems that entails.

    1. fredwilson

      valuations are the exhaust from a negotiation between an investor and an entrepreneur about two things;amount raisedamount of dilutionentrepreneurs should raise 12-24 months of capital for 10-20% of the company every time they raise capitalit’s really not more complicated than that

      1. Kirsten Lambertsen

        Now there’s a nugget I’ll be using the next three months 🙂 Fred Wilson says so!

  9. Jorge M. Torres

    Lately, I’m seeing founders who are spending lots of time negotiating caps, discounts, and other terms associated with closing a round of convertible debt. Seems like they might be better off spending that time negotiating a priced equity round.

    1. fredwilson

      exactly. its nonsense.

    2. Judd Morgenstern

      We are pursuing the convertible route because we were told it was simpler, faster, cheaper than priced rounds, and so far it has been the opposite.The amount of time spent working the math on different cases using multiple variables (discount, cap, interest, triggers, time, etc) – and communicating with lawyers & investors – when you should be building the product & company is a huge opportunity cost. And end of day, you don’t even have the peace of mind knowing how much friends & family own and how much you’ll get diluted.

  10. Richard

    A cap is just a price in sheeps clothing.

    1. fredwilson

      a price with a full ratchet!

      1. Richard

        Have you come across strategies where you start with an equity deal and the VC grants call options back to the company at a strike price giving the VC some fixed roi? 

        1. fredwilson

          no. sounds like a headache.

          1. Richard

            Cant help but to think of Put-Call Parity (Equity / Debt / Derivatives really are all functions of one another).

  11. Kirsten Lambertsen

    As a first-time fund-raiser (my first venture was bootstrapped, mostly) I am starting to see your point here. Convertible debt sounds really appealing at first. But…If I know how much I want to raise, and I know how long it’s going to last, and I know how much equity I’m willing to part with at this stage, I guess I know the valuation I want.I think it is a psychological thing. It just all seems ‘friendlier’ to postpone setting the valuation – to let the valuation sort of get set for us later, by someone else, in the next round. Then we can all just blame the valuation on the VC 😉 Even if, as Rich points out, we’re kidding ourselves.

    1. ShanaC

      congrats, kirsten.Is kicking the can down the road though a problem? What if the market bottoms out when it comes to the Convertible note?

      1. Kirsten Lambertsen

        Thanks, Shana :-)I’ve been asking that question, too. And the answer (which sounds familiar) is that convertible debt isn’t really a debt instrument; it’s an equity instrument. Yep, that’s what the lawyers say.

        1. ShanaC

          that has aspects of a debt instruments. so you still have a kick the can down the road problem…

          1. Kirsten Lambertsen

            Yep. The theory is that the debt aspect of it is never intended to actually come into play. It’s a way to let early investors buy more equity for zero cost later, as their debt earns interest over time, and that interest is figured in at the time of conversion.If you go belly up before the note converts, you do have to pay that debt before paying any equity holders (that’s if you even have any assets to sell at that point), but under a C corp you personally don’t owe anybody anything.

  12. Elia Freedman

    I’ve done both equity and convertible debt deals, although the debt deal I did gave the investors the option of converting. I don’t know if I would do a debt deal like this again. You touched in this briefly, Fred, but the alignment between what the business needs and what the debt holders need is out of whack. For instance, I am spending money every quarter repaying debt when we haven’t found the sustainable revenues in our business yet. So I’m basically spending time drumming up business to repay the debt rather than focusing on how to make the business successful long-term. From their perspective, this is optimal. Either we make it or we force the issue and move on.

  13. Naval Ravikant

    This week, we announced free basic Series Seed closings, all online, for any Delaware companies, whether or not they use AngelList to raise money: . The only remaining argument for notes is variable pricing and rolling closes, which are still easier with notes. But investors generally prefer, and should get, equity.

    1. William Mougayar

      I saw that this week. Congratulations!

    2. fredwilson

      Thanks for stopping by and sharing that with us Naval. Great work and great stuff

    3. Guest

      well they get equity on conversion… oh and thanks for posting the docs!

    4. Kirsten Lambertsen

      Just saw this elsewhere. Great tool for start-ups. Thank you 🙂

    5. Antone Johnson

      That is a great service. I look forward to seeing it in action. That said, as I posted below, I think there’s a point beyond which DIY is dangerous for entrepreneurs; a little good advice from an experienced startup lawyer goes a long way.

      1. naval

        Anton, it works in conjunction with your lawyer. We aren’t practicing law. The lawyers that we’ve partnered with like it because it saves them back and forth papering and puts the process on rails. But a lawyer is still definitely needed. Email me and we’d be happy to walk you through it.

    6. Nate Quigley

      So happy to learn about this. We used Series Seed docs in our seed round. This would have made it even easier. Thanks.

    7. Greg Biggers

      Love the near real time innovation reflected in Angel List and the new closing feature.BTW, at Genomera, we did a rolling close using the Series Seed docs. No reason that’s only possible with notes.

  14. ShanaC

    The entrepreneur can’t get screwed later when the price drops on them. And the investors can’t get screwed later when the price jumps on them. This is a big deal. I don’t understand why folks don’t understand it.It might be that people are afraid of getting screwed in the pricing discussion beforehand…

  15. John Revay

    “My wife, aka Gotham Gal, does a fair bit of seed investing and she has done her share of convertible debt investments, always with a reasonable cap, but she also prefers a priced equity round.”I remember when she blogged about it last year….. the mensch factor…

  16. markslater

    what part of a cap is not a price? Caps are prices so where is the beef?

    1. fredwilson

      Caps are prices with full ratchet down. Its a bad deal for the entrepreneur

      1. markslater

        all depends on the priced round. Its a bad deal for the entrepreneur any way you slice it if they don’t execute.

        1. fredwilson

          What if they execute brilliantly and the market implodes because some big company mispriced their IPO and the stock is down 60%?

          1. markslater

            so the other side of that (equity) ends up how in this scenario?

          2. fredwilson

            The note converts at a drastically lower price

          3. Guest

            floor it!

  17. markslater

    i’ll be the contrarian as we raised a 7 figure round from a venture firm using a debt intrsrument.Notes are founder friendly. This is why VC’s generally don’t like them. They are founder friendly because the company can defer pricing until the fog lifts from the opportunity. Pricing in the earliest of stages is a completely subjective and investor friendly approach. (why should it be that i give up 20% of the company for x dollars? )There are no comps, there is no DCF mechanic, there is only what an investor feels he is prepared to pay for the opportunity.notes are great things for entrepreneurs. Notes are done quickly (quicker than equity and far less expensive) can provide for investor pricing protection through caps, and are a financing vehicle that allows both parties to get much more clarity on valuation.

    1. fredwilson

      Founder friendly until the market collapses on you and you sold 75% of the business in your seed round

      1. markslater

        then you are f**ked anyway – and so is the investor.I had a CD in my left hand and a term sheet in my right in march i took the one in my left because we had to move very quickly. I signed ONE document and a week later was deploying the capital.I can tell you first hand that the docs we are creating and signing today as we price are extensive and expensive. I would not be around as a company if i had chosen that approach in march. today we are properly ready to go through the process, and price and more than happy to reward those who aligned with us in march and provided us with our launchpad – they took a risk and they are going to get the benefit they fully deserve with the cap. I don’t have a problem with that.

        1. fredwilson

          Look at naval’s comment elsewhere in this threadWe close Srs A rounds in less than a week for less than 5k with no investor counsel. We use boilerplate docs.

          1. markslater

            unfortunately – you are just about alone in this. (maybe B feld does – i dont know) – this is absolutely not the experience with most other of your peers.There is a firm on the west coast that we chatted with that guarantees a 2 week close and makes an investment purely on the back of the docs of the existing investors. They have a phrase for their process – its a formulaic approach of some sort. I think one or two of your companies may have taken money from them. I know that rich worked with themIts an interesting approach for sure – very founder friendly

          2. Mary-Alice Miller

            Do your boilerplate docs include protective provisions, information rights, a board seat or preemptive rights? I see a lot of focus in the thread on valuation, which is obviously a very important consideration, but a lot of equity rounds include additional provisions that impact control and flexibility.

          3. fredwilson

            yes. i would call them lightweight governance and rights and very little if any control. this is early stage. the founders control the company.

          4. JamesHRH

            This should be SoP & if it isn’t, you have the wrong VC.

          5. Antone Johnson

            Fred, will all due respect, USV is an outlier. I haven’t done what you describe once in 16 years serving as company counsel. The “boilerplate” deals my clients have done are limited to convertible notes or convertible “securities” like those FI and WSGR just released, including with accelerators such as YC and 500S.I appreciate your drive to innovate and streamline things, as well as Naval’s, but to represent it as a viable alternative for most seed-stage startups is misleading. (FWIW, I also haven’t done a Series Seed deal yet in the couple years it’s existed.) The terms and nuances are old hat to VCs, but to most entrepreneurs, nothing is boilerplate, and depending on bargaining leverage, everything or nothing is negotiable, or anywhere in between.My experience, working exclusively with early stage startups on the west coast, is that, as Paul Graham famously tweeted, “Convertible notes have won,” for all the reasons he’s cited. There is no easier, quicker, simpler, cheaper way to slap down some paperwork and have money in the bank for a new startup TODAY, with some reasonable investor protections as a debt holder, without placing the company at undue risk, especially when it’s only the first tranche of a rolling process (i.e., $100K from angel #1, $50K from angel #2 a few weeks later, and so on). Fifteen pages of documents instead of 80. No amendments to the certificate of incorporation (which can take weeks to clear in CA). No wrangling over carve-outs to the anti-dilution and protective provisions for certain types of equity issuances, or thresholds below which certain investor rights fall away.Convertible notes by their nature are quick-and-dirty, an efficient “hack” for raising relatively small amounts of capital for relatively short periods of time, designed to be temporary. Legally speaking, priced equity rounds are a different animal — not rocket science, which is why associates do them at most big firms, but not trivial either. Layering in a new class of preferred stock, even on streamlined forms, should be considered a BIG DEAL to founders, which is why it doesn’t lend itself to boilerplate treatment. Unintended consequences are all but guaranteed with the use of boilerplate docs. Even if you understand every word in the documents, what you don’t know is what isn’t in there, whether and how much it matters, or the broader legal and regulatory context. For example, who gets to vote, and how, when you go to sell your company? “Well the documents say…” Yes, but is it governed by DE or CA law? Trick question: It’s governed by aspects of both. “Wait, we’re a Delaware corporation!” but if somebody goes through the Section 2115 analysis, because of where your investors are located, depending on the proportion of shares owned, CA will consider you a “quasi-CA corporation” and insist that some of its corporate laws apply. Sometimes it really doesn’t matter; other times, when looking at things like selling the company or paying dividends or buying back shares, it matters enough to spend $10K or $15K more in the early days to get things done right.Look, I’m no fan of big law firms and their bloated cost structure. In fact I’ve launched a head-on assault on their model, as have many of my colleagues at other small firms, by providing similar services on these deals for roughly half the cost. But startup corporate lawyers do exist for a reason. Using a medical analogy, a certain kind of bump on your skin might be ignored for a while, treated with some over-the-counter cream at home — but the reason dermatologists exist is to be able to tell for certain whether it’s just a mole or a melanoma that will metastasize and kill you within six months unless you begin immediate chemotherapy.

          6. fredwilson

            there is a reason we are doing what we are doing. we think equity is better. so we are making sure it is as cheap and easy as debt for the entrepreneur. debt has won if equity is harder. maybe not if they are the same.

          7. Joe Wallin

            Fred, I just wanted to say–I think this is awesome! That is all.

  18. Kirsten Lambertsen

    It would be cool if @bfeld chimed in here, since it’s TechStars’s CD templates that so many startups use.

    1. bfeld

      I’m joining this particular party late and reading through the comments it sounds like pretty much everything that might be said has been said. Obviously there are strongly different positions which generate a long set of opposing perspectives.It’s also the case that this isn’t normalized by investor, geography, or definition of what a “seed” or “Series A” deal is.As an investor, I’d always rather do a priced round. I fall in the same category as Fred on this and echo most of what he’s said.At TechStars, our investment (via TechStars) is actually in equity. We then have a convertible note (Star Power Partners) which has a cap so it’s a hybrid. This note is the base for other notes in some cases; in others the companies go straight to an equity round. We (Star Power Partners) does it this way because the note is intended to help out during the program (it’s given at the beginning of the program), not be a “post program financing event.”As with many things, there is no right answer and I’m sure there will continue to be many debates about the best approach.I think the one thing everyone agrees on is that there is no value in paying lawyers a lot of money at this stage. In my fantasy world, it would be done on a handshake (which I have done several times – no documentation – and it’s worked out fine.)

      1. Kirsten Lambertsen

        Thank you for adding your 2 cents 🙂 The whole thing can be a little dizzying and exhausting the first time out. It helps a lot to get a broad input of perspectives from experienced people.

      2. fredwilson

        handshake partnerswhat a great idea for a VC firm

  19. edzimmerman

    a few years back, we at #Lowenstein created a form set of lightweight series A docs. Fred Wilson was kind enough to review them to ensure that when we’re opposite one another, very little discussion need be had over terms. Last year we closed more than 350 VC deals. They really can be no hassle docs as a starting point for deals. This assumes, of course, that BOTH sides are reasonable and are receiving guidance from people who have been down the road of venture deals many, many times. That same assumptions applies to Note deals. We’ve seen many instances in which multiple angels want to tinker with the notes. Similarly, we’ve seen many instances in which angels have hung up a subsequent financing because they’ve refused to consent to conversion and asserted that the Notes didn’t obligate them to convert. That happens far less frequently in UP markets than in down markets but do you really know what 2013 holds in store? Get ready to see more of those conversion issues come to the fore in the next 9 months as gravity impacts seed/A round valuations. Fred is, as usual, correct — just line up with your partner now on some very vanilla/low hassle priced docs.

    1. fredwilson

      #wisdom and #experience is being shared here folks

  20. John Revay

    “Most experienced venture lawyers have a standard form of “lightweight Seed” or “lightweight Series A” documents that can be signed without negotation on both sides.”I know ycombinator has posted some sample docs from WSG&R.…Not to take away the value that these venture lawyers bring to the table, – it would be great – if there were a set of sample docs available say on AVC – right nav Resources

    1. Mary-Alice Miller

      Although lighter, these docs still have provisions that you don’t typically see in convertible debt docs – 1) protective provisions (which give investors a block on a sale at a very early stage and say over the size, investor group and terms of the next round), 2) preemptive rights (and one of the theories around debt is to feel each other out before jumping in bed together) and 3) information rights (which can put pressure on the company to focus on early returns).

    2. John Revay

      Found this in the archives…Asked and answered

  21. chris dixon

    I generally agree on equity vs converts. But I will say that, empirically, the average equity financing costs $20k at a minimum. Probably $30k on average. Maybe if you are USV you can force Gunderson et al to charge $5k or insist on standardized docs. But in the messy process of angel rounds all sorts of things make this hard. Companies have legacy law firms and incorporation docs, they might be suspicious of investor suggested docs, and angels/seed stage entrepreneurs don’t have much pricing leverage with the big startup law firms. I’d love to see this change as I’m definitely in favor of equity.

    1. markslater

      yes – our note cost $1900I can promise that once we finish the priced round it will be in the 20-30k range.Oh and we get stuck with the investor bill too..

    2. Guest

      all great points…biggest one is time and cash flow (see @f023f4cd655c3500c33f9a85f6659d70:disqus ‘s comment).

    3. David Semeria

      One of the main reasons for the large legal bills is because the docs involve a lot of work, and the main reason they involve a lot of work is because they are riddled with terms that exist only in the venture sector….

    4. fredwilson

      great point chris

  22. Dave McClure

    Fred: while I don’t disagree with you that equity is better than debt in almost all cases, I think both you and mark are missing the biggest advantage in doing notes (at least for the founder, but sometimes also for us investors as well) — it’s that if you do notes, you don’t have to wait for all investors to agree on price at same time b4 executing docs & getting money in the bank.with priced rounds, ALL investors in the round must agree on price AT THE SAME TIME. this invariably forces the round to take more time, and the founder can’t bring in capital until all parties agree on terms, or at least a notable lead investor sets terms that the founder knows others will agree to.with notes, a founder can agree to terms quickly even if price is not nailed down perfectly, and they can get some capital in the door and get rolling.this is the main benefit of doing notes over a full price round — it’s speed and flexibility, and the lack of needing to wait for all investors to make a decision at same might paraphrase: “Perfection (re: valuation / priced round) is the enemy of Good Enough

    1. William Mougayar

      That’s a good point, and I went through exactly what you described in a recent debt deal, and it benefited me. But even as equity deal, can’t one investor still advance some funds ahead of closing anyways against a personal note which is then converted to equity. I’ve done that too.

      1. Dave McClure

        unlikely & not guaranteed. dependent upon investor idiosyncrasy.

    2. Kirsten Lambertsen

      Really good point. If I think I’ll need more than, say, two parties to participate in and complete a round, CD is a smart route.

    3. David Semeria

      On the stock market a deal is priced via book building, in which investors communicate their interest at a series of different price levels. The round closes at the highest price at which the deal can be done.This technique worked very well for our previous round and we are using it again for our current one.

      1. Dave McClure

        not how it works in practice in startup world, and regardless still takes time & coordination. money now is also worth more than money later.

    4. fredwilson

      great discussion on this Dave. i understand your points. but i don’t like them and i don’t practice them in my life. different strokes for different folks.

  23. William Carleton

    The biggest problem I see with the new convertible security Adeo and Yokum have come up with – a convertible note without the note, you might say – is the lack of priority given to the investor on liquidation.Even if the convertible security gives the holder the option to convert into common stock prior to any liquidation, the investor is then sharing pro rata with the founders, which won’t seem fair to the extent that cash being distributed came from the investor.Matt Bartus has a good post on the mechanics of all this.

  24. awaldstein

    Timely!My personal decision for a raise around a project even after listening to this carefully is still solid for me.Speed. Ease. Cost. And some peace of mind.

  25. george

    Good stuff: I think viewpoint 2 is very important – financial objectives are misaligned from day one. The financial structure and strategies should be designed to support several future business cycles and create some capital sanctuary when targets miss; I don’t believe convertible debt supports those objectives.

  26. alokdeshpande

    Interesting and timely post. I’ve been following your blog for some time.Let me offer my 2 cents as an early stage, first time entrepreneur that’s raising capital for a new site.Simply put, I want my seed investors to make as much as possible….especially if they are friends/family. These are the people that are taking a risk on me. They are investing mostly on the idea, the team and faith. I want them to be rewarded. I’m passionate about our business, our impact and my investors…..I come last. A priced equity round gives them clarity. And, for this particular case, it costs the same as convertible debt.At any stage of raising capital (FF, Angel, VC, Exit), I want my investors to do as well as possible. They make money, my vision becomes reality and society wins (at least for our venture). Isn’t that the goal of the entrepreneur?

    1. fredwilson

      i think many people lose sight of the value of letting those who wrote the first check have a really good deal as long as it doesn’t cost you a ton of equity

  27. goldwerger

    As entrepreneur, over 4 ventures I’ve raised 5 equity rounds, 4 venture lending, 1 private equity, and 1 M&A. I’ve reached a simple conclusion – people (both entrepreneurs and investors, and lawyers) grossly over complicate things, and grossly under value simplicity.2 of the things that really boil the blood of entrepreneurs are the side effects of anti dilution and liquidation preferences. Mark Suster does a really nice job demonstrating how these come into effect in a convertible debt scenario (Fred’s link above).But I never really got the investor perspective on this one either. When, ever, is leaving things open for future discussion/debate/circumstances does any good? Should everyone hold their breath in anticipation to see who got lucky and who got screwed in the subsequent round?My view is more radical, and clearly 99% of the industry will not subscribe to it. The venture industry has created a common business practice everyone is familiar with, but it doesn’t mean it’s a good one. When investors invest in a traditional business, the discussion often boils down to “I will give you X, and you will give me Y% in return, and we are partners”. Investors give money, operators build companies, and the world does not collapse when the shop owner, medical equipment distributor, or spa chain franchise operates without a complicated board or multiple share classes.I get the necessities of protective provisions. But I do sincerely believe our industry has too many smart people thinking too hard and too long about too many edge scenarios. This does a great job taking care of 1% of the times. But it ruins for the other 99%. And, on balance, destroys value.I hope we will see in the future a truly revisionist movement to a simpler way of working together. I admit I do not yet have the answer to this one, but I am thinking about it a lot. I hope you do too.

    1. fredwilson

      i am all for more simplicity and our firm is doing what we can to create it in our deals

    2. PhilipSugar

      I have raised four rounds myself and have done too many deals to think about.You are totally right but I don’t know how you take care of the edge scenarios other than to trust the person and that is really hard. Funny that our deals in Vegas are done on that basis.I had a great business professor at Wharton (Myles Bass, just a great guy) would tell me write the intentions and screw all the lawyer stuff because if somebody feels they got screwed they would sue whatever the contract said.He always likened it to a prenup. You know you should probably have one but the negotiation of it probably kills the marriage (if you cheat on me, do me so wrong…….wait??? you are going to do that??)

      1. goldwerger

        Philip, this reminds me the negotiation of “for cause” clauses. If ever I saw an unsavory discussion… In reality, companies don’t terminate for cause as the legal risk of doing that is high, and when someone actually steals, you don’t need a contract to fire and sue their asses for damages.

        1. PhilipSugar

          Oh yes, you are totally right. One of the reasons I hate employment contracts.

      2. Muhammadatt

        OT, but Myles Bass was awesome. One of my favorite professors at Wharton.

        1. PhilipSugar

          Not off topic….he was a great business mind. I was sorry we lost him. Funny but true: my brother’s only C was a grade from him. My brother basically laid out CarMax’s business plan and Myles said it would never work…. 🙂

  28. ralphacosta

    Fred – quick question – what is the difference between a Bridge Loan and Convertible Debt?

    1. David Semeria

      A loan is just that, a loan – which must be re-payed. A convertible note is debt issued with the explicit intention of converting into equity, and so (unless the conversion never happens) it doesn’t represent a long-term liability.

  29. Mark Organ

    I’ve raised more than 10 rounds now, including 3 converts, in my startups and I can say, without a doubt, that the convertible note is an essential tool for fundraising founders. It is indeed much faster to raise and is absolutely more founder-friendly, if done correctly. Dave McClure hits on the #1 reason – rolling closes, which are helped by having variable closings. The speed by which the founder can acquire and deploy capital in the crucial early years of the venture more than outweighs the Susterian/F.Wilsonian argument of stealth liquidation preferences, ratchets, etc. And there’s no question that negotiating caps & discounts is much faster than negotiating the price on a pref equity round – especially because they can vary by investor. There certainly are annoyances, particularly with pricing options but again the benefits outweigh the costs & annoyances.It’s important to note these convertible note rounds are also typically quite modest, sub-$1M. The effect of a round done below the cap is not really that big of a deal. So what, give the early funders a good deal, they deserve it. The pref A round should dwarf the size of the convertible, and the presence of the earlier convertible note makes it much more likely that the A round gets done at a significantly higher price.One way to give everyone what they want is to raise a convertible and a priced round simultaneously. It’s what I did for my seed round at Influitive and it worked remarkably well. If you google Influitive seed round you can find some info on it on the Web.

    1. William Mougayar

      Great to see you chime in on this, Mark! (I sent you an email and got that auto-response)

    2. fredwilson

      it works incredibly well in rising markets. we will see how well it works in falling ones.

  30. JamesHRH

    Cowboy up people.

  31. William Mougayar

    There is a nice side conversation going on Twitter related to this. Mark Ury storified it:

    1. Abdallah Al-Hakim

      it is a fascinating side discussion!! How does one discover storify stories – is it through twitter or do they have a decent dashboard for discovery? I guess I can check it out myself 🙂

      1. William Mougayar

        They have a entry page with popular ones & by category.

    2. John Revay

      Thank you for sharing – it was an interesting read/Debate

  32. Abdallah Al-Hakim

    I do not know the answer for this but do you think convertible debt is suited better for other sectors. For example, what do you think of Biotech sector using convertible debts. Here is an article that I read by Bruce Booth from Atlas Ventures about using convertible ventures in Biotech… OR are the underlying disadvantages the same regardless of the sectors

  33. Steve Palmer

    As a new startup founder it is good to have a knowledgeable advisor in your corner (Charlie). It is a lot to consider, navigate and understand. It is hard finding capital let alone being in position to choose how you want to receive it. Do we really have a choice between CD and equity? It’s not like VC/Angels are Lending Tree; we have to evaluate the options presented before us, who might be interested and their preferences. I suppose if the options were between you, Fred or Dave McClure, we truly have a choice between equity or CD, respectively. Since this is unlikely, I get the impression we founders will need to try to make the best of whatever options we are presented with or go without capital.More easily stated: don’t we founders have to take what we can get on some level?

    1. fredwilson

      as JLM would say “you get what you negotiate for”

  34. Brad Lindenberg

    This is such an interesting post Fred. I just received a term sheet from an investor which contained a convertible note with a ratchet and no floor! As an entrepreneur it is close to impossible to be aligned with an investor on such terms. Each founder will have a different view, but I value alignment over valuation.If an investor wants a ratchet that can screw us in the short term, they are not the right investors to have on board. It doesn’t represent an alignment of interests – it represents a one-night stand. If you want to build a billion dollar business over the long term, founders and investors need to see eye to eye over the long term and that means an equity deal if the founder prefers this.To quote Fred in point #2″I don’t understand why folks don’t understand it.”.The excuse that investors use is that ‘it is hard to value a startup, so lets leave this to the next round once you’ve got some traction’. Well startups are not mean’t to be valued traditionally. It’s a thumb suck at best. If an investors is looking to do a DCF, they they should be buying mature businesses not investing in startups. If an investor does not have the courage to price the business, then they shouldn’t invest in it and the entrepreneur should look elsewhere. The right idea at the right time with the right team should warrant a price. Why should founders have the ‘gamble’ their equity?The reality is that investors need to back the idea, the market, the vision and the team and figure out what they need to realise this vision. If you like those things, work out how much is needed, work out how much the founders are prepared to part with, set a 1x liquidation pref, and get the party started.I wouldn’t sleep as well at night knowing that I might end up parting with 40, 50. 60. 70% of the company if we don’t reach specific milestones quickly. If I was on the other side of the table as Fred is, I’d rather the founders I invest in, focus on product and the business rather than have the stress of knowing they could be screwed. The reality is that business are not built overnight and that many of the consumer internet business that are worth billions today never had a revenue model when they started out – Google, Twitter, Facebook etc.How can a ratchet be anything other than a ticking time bomb if you don’t yet have a revenue model? It makes no sense to me and as a founder represents little more than some financial trickery. Our business does have a revenue model but its still a new product and we need to market it and get it out there and that can and will take time. I’d rather do it without a ticking time bomb under my seat and with the peace of mind that I know where I stand, and that means an equity deal.Startups should not be about financial engineering. They should be about software engineering and marketing. Founders deserve to have the peace of mind that they can get on and build their product and business and in my view, the only way to ensure the founders full attention is focussed on building company value is by pricing the equity up front.I’m glad that you have surfaced this topic Fred.I’d do a deal with USV any day if you’re of that mindset.

  35. Tom Labus

    The most important part of any financing deal is the simplicity, brevity and clarity of the document language. That goes a long way in making everyone a lot safer.Look at the Bear Stearns financing deal with JPM. Bear thought the doc gave they 28 days of backing yet it was pulled out from under them in less than 48 hrs. Both sides read into the wording what they wanted to see.

  36. pointsnfigures

    I won’t invest in an open ended convertible debt company, no matter how good. If the entrepreneur doesn’t want to have a meaningful discussion about valuation, it says a lot about them. I will do a convert note with a realistic cap. But this is for a bridge or seed only. Best is to price the company and gauge interest.

  37. VentureDocs

    Jumping in way too late here, but we’ve just launched a freepublic beta for producing fully customized docs, not boilerplate, for preferredstock (light or heavy versions), convertible note and common stock financingsat need feedback, so please go check it out.One of the big reasons for the popularity of notes is theperception that they are cheaper to document than a fully baked or even a lightpreferred stock round. That’s why weplan to price everything the same, whether it’s a preferred stock, convertiblenote or common stock deal. Investors andcompanies should get what they need and shouldn’t have to compromise onstructure or terms because of transaction costs.Bo

  38. Matt McCall

    This is a result of the frothy markets. I did a blog post on this (versus clogging up the comments) showing the dynamics between a hot market (LA) versus a more traditional market (Chicago) and how the former has more Convertible Debt deals and the latter almost none. http://www.builtinchicago.o

    1. fredwilson

      i am sure you are right Matt

    2. Casey Allen

      I’m glad you wrote that post, @4256fb83c89c12a2f4e05f762c403d0e:disqus.What I wish people talked about more is how convertible debt (and soon to be convertible equity) is an animal unique to SF, and to a much, much lesser extent, L.A. and NYC.But to the other 99% of us, the whole notion of taking so much unnecessary risk on terms so friendly to the founders and unfriendly to investors is simply stupid for both sides. Oversubscribed angel rounds are virtually unheard of in my region, and I know ours is not unique.PG was largely the one that made convertible notes seem “normal”. Everyone conveniently forgets that. Just like they seem to forget that his companies are in a completely different league, one that almost all other startups are not in.

  39. paramendra

    Many great things are simple.

  40. John Revay

    I spent a lot of time late last night bobbing and weaving through all of the threads on this topic scanning all of the related posts – for which there were many.Best Fred Wilson line – was the post you did a little over two years ago….”…But I am a sophisticated investor. I do this for a living. I can negotiate a fair price with an entrepreneur in five minutes…..” Some of the roads I went down were…http://www.startupcompanyla

  41. Brad Wisler

    Great points, Fred. I’ve always preferred priced equity deals, and we never did a convertible debt deal until very recently. It’s much easier to manage a portfolio and track success when you know exactly what you own. We’re usually first money in, so we typically have the luxury of pricing the round. In one recent case, though, convertible debt made sense because the company had already raised a significant amount of convertible debt. If we were leading a legitimate series A with a 7 figure investment, pricing the round would be the obvious way to go, but we simply don’t make investments large enough to pull that off. Bottom line – you have to write a big check to set the price if there are already a lot of names on the cap table. Convertible debt opens the door to a larger pool of investors and allows for more flexibility in the timeline. A private placement can give founders the same reach, but PPM’s get stale pretty quickly, so they require some serious cat herding.When I decide to pick a winner, I try to get the best terms I can without creating a distraction for the founders or a conflict with other investors. Trying to price the round in this case would have done both. My preference in a case like this is to take convertible debt, but protect against a huge jump in price by earning some options or warrant coverage along the way. This is tough to do for passive investors who simply write checks, but I think it’s a good model for seed investors who are getting their hands dirty.

  42. Teresa Cutter

    Pros of Converts (Vs Equity): less dilutive, tax deductible interest expense is, give up less of the company when you have a revenue stream, only giving up parts of the company when you are doing well & can afford it (i.e. above the conversion price).Cons of Converts (When to do Equity) – Difficult to derive a conversion price, Likely conflict in valuations as you move forward, burden of interest expense if no revenue to cover it, unappealing  terms given the funding agent/convert holder will set high barriers if you don’t have revenue given they want to get paid their interest and then get paid back.

  43. Teresa Cutter

    Pros of Converts (Vs Equity): less dilutive, tax deductible interest expense is, give up less of the company when you have a revenue stream, only giving up parts of the company when you are doing well & can afford it (i.e. above the conversion price).Cons of Converts (When to do Equity) – Difficult to derive a conversion price, Likely conflict in valuations as you move forward, burden of interest expense if no revenue to cover it, unappealing  terms given the funding agent/convert holder will set high barriers if you don’t have revenue given they want to get paid their interest and then get paid back.

  44. fredwilson

    A cap and a floor sounds like a price with a little wiggle room to me. I prefer the simplicity of a price without the wiggle room.

  45. markslater

    yes absolutely a no sense in having a roof without a floor.

  46. fredwilson

    Keep the price and figure out who you want in and who you don’t

  47. Hector

    The alternative maybe much worse for your friends and family if not. If the price upfront is right, they will take it (or not). If they convert at market prices, when an institutional gets in, their money invested at the highest risk would become irrelevant.

  48. fredwilson

    Good points on F&F Charlie

  49. markslater

    feeling a little argumentitive this morning! kids have been running me ragged since 5!

  50. fredwilson

    Me too. Give and take creates a lot of value for everyone

  51. Hector

    Pricing it at the outset… setting a cap (up and low). Let’s face it, F&Fs like to see you succeed, and that is it. It is emotional, not a financial decision. It is the at the entrepreneur’s interest to protect them. Good or bad. Pricing takes uncertainty out of the equation.

  52. markslater

    this is bang on. Fred and his circle are simply not representative of the larger sandbox that we entrepreneurs play in and raise money from.And i mean that as a compliment.

  53. Hector

    As a founder, or as an operator later, you have to protect the interests of your shareholders El 08/09/2012, a las 19:13, “Disqus” <[email protected]> escribió:

  54. ShanaC

    at that point why not just do raw equity, since the whole point is to not have the “what is the value” discussion, of which introducing a cap and floor does

  55. Wavelengths

    Fair enough.

  56. Wavelengths

    But if it isn’t a $1M idea from the start, then it’s a bakery, or flower shop, or restaurant — not a real investible business enterprise of the sort we discuss here. Right?

  57. Wavelengths

    Yeah, but I’d give Mom an upvote for asking a very important business question. 😉

  58. Hector

    maybe that’s why most founders who end up being funded are not first timers. Fiduciary responsibility must be taught, learned and exercised from day 1. Protecting existing shareholders is 101 (and F&F’s are the ones with the highest risks). Pricing at the outset takes it all out. Mistakes may be made with valuations, given, but it takes one variable out of the equation. El 08/09/2012, a las 19:26, “Disqus” <[email protected]> escribió:

  59. John Revay


  60. Hector

    True, anti-dilution might be the way to go for founders/entrepreneurs and early F&F’s … convertible or equity or not would become a non-issue, a technicality …. shouldn’t it become a standard TS provision at seed-stage? Wonder if anyone in the investment community would reply. El 08/09/2012, a las 19:40, “Disqus” <[email protected]> escribió:

  61. markslater

    me too

  62. Wavelengths

    Agreed. But if, as the founder, I can’t already see the $multiM value in the reasonable near future (throwing in a lot of worst-case scenarios to keep me grounded in my optimism), then I really don’t have enough potential in my business to start talking about bringing in investors.Maybe I think of that $1M number Fred mentioned as a reasonable threshold that the founder might keep in mind.Even if the valuation isn’t formal at the outset, it seems like the founder should have a valuation in his/her head. Just as a reality check.

  63. Kirsten Lambertsen

    Great point.

  64. David Semeria

    It depends on the investors. It didn’t happen to us, but if there were one or more investors who could really make a difference and they were in at a lower price then it could certainly make sense to price the deal so they’re included.

  65. fredwilson

    email and twitter