Late Stage Convertible Debt

I've written about convertible debt a few times on this blog, most notably here and here. My general take on convertible debt is that its very good for the founders and not very good for the investors in seed and early stage investments and a much better solution in late stage financings, which I mention at the end of the second linked post.

We have a good case study on late stage convertible debt today and I thought we should not miss an opportunity to talk about it. My partner Albert blogged about the $41mm Foursquare financing on the USV blog today. You will note that the investors bought convertible debt. And this is a classic situation where convertible debt was the optimal solution for everyone.

In the Foursquare situation, the convertible debt was purchased by a group of insiders led by USV and Andreeesen Horowitz. Both of our firms have been investors in Foursquare for several rounds and both of us own a meaningful stake in the company. Valuation is somewhat immaterial to us as our stake in the company is not going to increase much in this round of financing. But valuation is very material to the Foursquare management team because $41mm of capital is going to be dilutive at any valuation that would make sense here.

So the optimal structure is convertible debt. That means this round is not dilutive to the Foursquare management at this time. But it will be dilutive when the debt converts into equity, most likely at the next equity issuance. For the investors, we get the comfort of knowing that eventually our investment will become equity and we will not have to price it. Someone else will.

In Foursquare's specific situation, it makes even more sense because the company has just released an entirely new iOS version which gets iOS to parity with Android and completes the transition toward social search and curation which we all believe better positions the company in the minds of consumers. Also, the revenue model is in its early stages and will be much more developed in the next year. In situations where a valuation inflection point is on the horizon, convertible debt can be an excellent structure for everyone involved. And that is very much the case here.

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Comments (Archived):

  1. Adrian Bye

    best of luck getting this to work

  2. pointsnfigures

    I am also not a fan of convert debt in early rounds, but see it more and more. My compromise has been to do a capped convert debt note for seed rounds only. If the cap is a realistic valuation, and I get a 20% discount then I feel more secure. Once the initial seed is raised (thinking 200-600k of financing), the next round should be a priced Series A round. I detest a continuous convert debt round with an ever higher cap. I won’t invest in any company with an uncapped convertible note at an early stage.I find that the reason no one wants to do a priced round early is they avoid the confrontation on valuation. You learn a lot about entrepreneurs when you have the valuation discussion.In the later rounds, I am curious-are you letting “the market” set the price rather than have control over the price?

    1. fredwilson

      you have to let the market set the price eventually. it can be deferred but not avoided.

      1. mlr3000

        So I mean, really, that’s what you did here. You deferred a tough call on valuation, right? If there was any consensus on what the company was worth, a price would’ve been found.Obviously, the investors get serious respect for investing >anyway<, even though they clearly felt the number was significantly lower than management’s numbers. But in startups “valuation inflection points” are nearly always on the horizon; unpriced later rounds are generally very rare.

        1. fredwilson

          yes

      2. ShanaC

        what’s the market in this case? I mean there are only so many vc funds

  3. JimHirshfield

    But there was an explicit valuation for this round, yes? I read there’s a new investor in the round, Silver Lake. So did they set the valuation for this round? And if so, why not put USV’s cash in equity at the valuation?

  4. JLM

    .Typical great lesson, generous information and real world example. This is why this blog is so powerful and useful. Thank you, Fred Wilson.What this teaches is the wisdom of finding a way — any way — to continue the growth of a promising company when the investors have a lot at stake but cannot really put their finger on a precise valuation. For whatever reason.Or, are unwilling to get down into the weeds to do just that perhaps fearing, just a tiny bit, the distractions and contentiousness such a discussion might entail. This apprehension may be driven by the inability to accurately gauge the impact of, as in this case, a pivot or new development in the company’s offering.At the end of the day, money is just a commodity which is priced based upon its risk/safety and utility — meaning its place in line come liquidation.Follow on money has the added burden of having to protect the earlier investment also. The prior dollars are a “sunk cost” in many ways. Not a nice thing to hear sometimes.This innate cleverness in making a deal to both provide adequate funding for growth and to forestall the unpleasantness of a knock down argument on valuation is exactly the mark of experienced venture capitalists. Financiers really.This is exactly the support that entrepreneurs need from their VCs to enable the entrepreneurs to focus on the only real exit path — building a great company.This is what you learn when you are a venture capitalist for a quarter of a century or more.Well played. Thanks for the learning.JLM.

    1. JamesHRH

      Its so clear: what, when, why.A little more how would be interesting…… πŸ˜‰

      1. ObjectMethodology.com

        What do you mean?

        1. JamesHRH

          what – CD funding; when – late, not early; why – b/c eventually the market has to set a price (Fred never bought that ‘the market’ was VC driven ‘B’ rounds – which is bang on).How – what else was considered? who proposed CD? etc.

          1. ObjectMethodology.com

            Yep, the old “how?” is always a bit vague in this world. It’s usually the key point. Example: How did you start your business? Usually you get the canned “I did a business plan.” That always leaves the “Huh?” on everyone’s lips. What gets left out is “I beat my feet on the pavement finding customers until I figured my business idea was viable.”So, in this case you’re asking who first talked to who about funding? What was the process for deciding funding type? Who were the players in the meetings?

          2. Ricardo Diz

            Sometimes when internal convertible debt rounds are done, they work as an alternative to a failed external financing round, buying more time (giving the burn rate) to get to a more significant round. In this case, they are simply called bridge loans, and typically convert bellow price at next round.Note: I’m not saying this is the case with Foursquare, I’m just pointing out what sometimes happens in the VC world.

          3. JamesHRH

            Ricardo – I wasn’t going to go there….. πŸ˜‰ I don’t think that is on The Bartender’s mind…..But, yes, a down round often comes out of a CD.

          4. Ricardo Diz

            lol, I figured that could be the case πŸ˜‰

          5. ObjectMethodology.com

            “bridge loans”Crystal clear now!

          6. ShanaC

            so why set a price in A rounds then?

          7. JamesHRH

            Some people argue that – SV Angel in particular claims not to care – but if you are a VC w LPs, you need to be more fine-grained on the percentage that you get. Valuation / Capital Raised / Percentage is the triangle – most VCs play with variable 1&2, b/c 3 is how they meet their obligations to LPs.

    2. fredwilson

      thanks for saying all that JLM. i appreciate it.

      1. JLM

        .This is exactly why I would trust you with both a bazooka and an aircraft carrier.Well played. HahaJLM.

        1. JamesHRH

          That’s a leap, isn’t it ;-)And I am pretty sure The Bartender is not going to start toting a bazooka around on the Vespa!

    3. ObjectMethodology.com

      “Typical great lesson, generous information and real world example.”This is what I come here for. Great stuff for a VC blog.

  5. William Mougayar

    Congratulations. There were rumours about Foursquare’s undergoing a round of finance, and this clears the air on the outcome. This type of transaction makes a lot of sense and it gives them plenty more runway to continue working on their vision.I discovered the updated Foursquare version yesterday and I like the freshness of its look and emphasis on search/explore.I’m a big advocate of Foursquare, and yesterday I was at my dentist and noticed they weren’t on it. I suggested they register as a venue. A couple of hours later, they had filled out their entire profile nicely, added Tips, Specials, and now the dentist is singing Foursquare’s praises.There’s an opportunity for Foursquare to be the trusted intermediary between users and venues/businesses. Users are expressing their “social loyalty” by checking in, but venues aren’t always aware of the activity of these users. One idea is to send email alerts to owners telling them that such a user has made a reservation at their establishment, or give them a Dashboard that identifies who is checking-in and their status. That way, if I’ve been to a place for the 10th time, I’ll get some recognition and the owners get the opportunity to recognize me. I really don’t care for perks that much. I just want good service.

    1. awaldstein

      Nicely said William.Raises the question whether community or moreso a marketplace of ‘places’ is part of the future here. Easier thought than done and honestly, unclear whether the behaviors are there to support it.Interest piqued though.

      1. William Mougayar

        What I was thinking is not to go against Yelp, but rather carve that other unique position.If I were to trust an intermediary between me and establishments I frequent, Foursquare is in the good position to be the one. Then, a number of revenue opportunities can emerge from there.

        1. awaldstein

          ‘Yelp’…what’s that?To me a reference not a discovery tool. Actually I use Yelp and Linked In exactly the same, to look something up after I’ve discovered it. Not a big fan nor user of either.All I can say to your last statement is to tread cautiously into the minefield of getting the SMB to pay. They can. They have. They are a nightmare of a target market to build a model on though.

          1. CJ

            I mostly use Yelp as reference too, but it’s a great discovery tool when you broaden your reach to an area. When we moved from Chicago to the burbs we used Yelp to find all of the good places to eat, drink, etc, using just our location. That’s discovery AND reference and will be hard to beat.

          2. awaldstein

            That’s their intent by design but it just never worked for me.I need personal recommendations for merchants and honestly, almost never go to a restaurant or bar wherever I am that hasn’t been referred.i may be the corner case here and not the market.

          3. CJ

            I don’t, I’ll take star ratings if there are enough of them. Or in the absence, as long as there aren’t any negatives that catch my eye.

          4. awaldstein

            Crisp observation on negatives.Personally, star systems leave me blank.

          5. PhilipSugar

            What I do find amusing if somebody has enough yelp or google ratings there is always some crazy nut job case with a super negative rating. Its almost a contrary indicator. I know they do enough business to reach a pyscho. My two favorite are the one where the guy pans the best sushi place on the east coast because the ceilings are low and they don’t serve some crappy philly cream cheese roll. Are you shitting me? Or the other at a great, great NYC pizza place near me where they serve at the counter and you go sit down. The guy says the “waitress” brought him his pizza but didn’t come back to check if his soda needed a refill (the soda machine is like a McDonald’s out in the open) because she just wanted to stand behind the counter.

          6. ShanaC

            Actually, I don’t think you are – Yelp is now highlighting my facebook friends who go to certain places

          7. PhilipSugar

            If I read Albert’s post correctly they are linking to credit cards so you pay with a registered credit card and Foursquare gets a cut.If that is linked back to the processor so the merchant gets $15 of a $20 purchase and doesn’t really ever have to reach into their pocket for the $5, that will work.I wrote about this an was arguing with somebody about that a couple of posts ago.If the merchant has to settle up at the end of the month and write a check…..not so much.

          8. awaldstein

            You have a keen sense on this piece Phil. I remember some discussions from a while back.So I can check in, get a discount or pre purchase my sandwiches through 4sq? As long as it is tied to the a transaction and you don’t need to change the SMBs behavior that could make sense.Guess as well, that no ties into inventory are needed.Such a juicy area with a lot of potential that is just so squishy and really hard to crack. Not only technically but also the behavior of the customers are really unknown as yet.

          9. PhilipSugar

            If you have to tie into the Point of Sale or Inventory System forget it. I have lots and lots of scars and missing teeth from looking at this.If its an automatic discount like I get on my credit card bill…..i.e. buy at Lowes and get an automatic 20% off that works. Seemless at the POS, you don’t say a word, and the cashier doesn’t have a clue. I know all the guys in this space really well, and that is doable.The last piece of the loop is closing how the merchant pays. If they just end up seeing $15 for a purchase instead of $20 that will work. If they have to dig into their pocket, it won’t.Its kind of like payroll deductions. You just pay it but don’t see it. I know the super smart elite people will say its the same but I assure you as a gun owning country bumpkin that is amusing to watch it is not :-)I have tons of experience in this area. A bar owner will do a mug club where they give away 25% more to a mug owner, but it kills them to do a 5% back promotion. Well logically how dumb is that? Sure as a Wharton finance guy I can do the NPV and TCO (mugs cost money and take space) calculations and show you which has a better ROI. Dare you to say that to an owner, they probably think you are cursing at them.In one case they are accepting breakage which happens to them every day. Employees steal, customers steal, suppliers try to give you crappy stuff. In the other they go damn I just gave that guy a free meal and he would have come anyway.

          10. awaldstein

            Thanks…Retail SMB is a mindset and a tough one and a mystery.Wine shops amaze me. Incredibly talented and smart people working for basically not a lot. Just fiercely independent and passionate about what they sell.Not a clue about how to acquire customers except a chalk board on the sidewalk.

          11. ShanaC

            how do they deal with that breakage?

          12. PhilipSugar

            How do you think?

          13. ShanaC

            getting annoyed and firing employees who steal – but beyond that, how

          14. LE

            “A bar owner will do a mug club where they give away 25% more to a mug owner, but it kills them to do a 5% back promotion.”Are you factoring in the fact that the cost of 25% more product is not the same as kicking back 5% cash?(Not that I doubt the logic I believe it’s true.)I think this is the same reason that people would rather have a cash back check on their credit card purchases then they would the equivalent minor discount (which they will forget about). Bump of gross check eom better than 98.99 vs. 99.99 paid.Similar to how people “waste” energy. You get a bill at the end of the month for $500 you don’t feed a meter on the hour that actually gives you a feel for the money you are wasting. If you did you probably would use less energy. (Gas purchase is another example of this you don’t really tie the miles drive to a cost it’s a gross thing you pay.)

          15. PhilipSugar

            We can try and speculate on the cost i.e. would the person only buy two mugs instead of three, in which case you are really losing out, or is it just the product, they buy three anyway. But that’s not my point.My point is that when you go to a merchant and say, cut me a check, give me cash, and you are asking that every month they don’t pay.That’s where all of us Ivy League Wharton types get confused. Yes if I can show you that if you spend a dollar and make two you should spend the dollar. Getting the person to take a dollar out of their pocket is really hard. That’s why every successful local play brings a business customers, gets in the transaction stream and essentially takes a discount. Think about group buying. They don’t say pay us X and we’ll do a discount promotion where the customer pays you less. No, they say I am going to give you money, money right now, not a penny out of your pocket.Frankly almost every successful marketing play in the local space looks more like a factoring company than a marketing company..

          16. robertdesideri

            The getting paid part is where a fresh approach is required. It’s a tough row. Your bar example hits the notes just right, it’s a behavioral problem.

          17. JamesHRH

            That’s so money – hope you are a Vince Vaughn fan.Would love to connect with you and learn more about your days in retail PoS.

          18. PhilipSugar

            More like decades. When you go to Stampede and use your loyalty card that’s us.

          19. LE

            “They are a nightmare of a target market to build a model on though.”How true. Not to mention a nightmare to get paid and to get to do anything (fill out forms, ad copy you name it). Mr. Owner (or their assistant) is distracted with a zillion things. A constant hounding is necessary.About the only thing I have seen move Mr. Owner (that I have previously mentioned) is to dangle in front of them what their competitors are doing that they envy. Also important to not make offers open ended must have clear deadlines and preferably the selling cycle is actually close to the deadline (they will put it off anyway so you might as well have it be urgent and last minute). Ad books with clear close dates work well. So something open ended like foursquare needs to invent an artificial deadline of sorts.I’ve mentioned this before (actually with respect to Dwolla) that the way to get merchants on board for these things is to incentive users of the services (foursquare/dwolla etc.) to sign up merchants in return for some reward, spiff, karma whatever. A sales force is expensive and they still have to get the ear of the owner. An existing customer already has the ear of the owner and can pitch the idea. (I did this at the sushi restaurant with dwolla just for fun similar to what William did with his dentist.)

    2. btrautsc

      really agree with that last paragraph… I think that small tavern feeling is what everyone wants – to be recognized for coming through the door a few times a week… both in the physical and virtual worlds.

      1. CJ

        It’s creepy but the feature with Square where your face pops up on the register when you come through the door sounds quite cool. No reason FourSquare shouldn’t emulate this and a lot of reasons the owners should use it to make their customers feel special, as long as they can sidestep the creepy factor.

        1. William Mougayar

          Yes, that could be set in your Privacy Settings, or maybe call them “Visit Settings”.

          1. CJ

            Especially at a restaurant or bar. That’s a killer app.

    3. Richard

      I tried this in a retail operation that i was a partner in.

      1. ObjectMethodology.com

        So what was the outcome?

        1. Richard

          Not very effective. Loyalty program reward the customers who already reap the greatest utility (product selection, price, service, location etc.) from your business. That why they patronize you so often. These are the first tier customers. They are already happy. The killer app is the one that increases the marginal utility to the the next tier of customers to turn these customers into top tier customer. 4SQ has the tools to do this. They should continue to use their APIs to generate data and create this type of value for the retailer.

          1. PhilipSugar

            Those are the ones that will leave you in a second if somebody serves them better. You either believe in taking care of your best customers, or take them for granted. That is an attitude where I love kicking people’s teeth in. I love telling somebody that I don’t see them anymore because they took me for granted. Love Social Distortion Song: http://www.youtube.com/watc

          2. Richard

            You are misreading the comment. Of course you focus on the best customers, by increasing their utility. Price may not be the highest valued utility for this group, focus on better offerings, products, services, etc.

    4. ShanaC

      Actually, the idea of using Foursquare to help organize good service is really brilliant.

      1. PhilipSugar

        How about give everybody great service?

    5. LE

      “I’m a big advocate of Foursquare, and yesterday I was at my dentist and noticed they weren’t on it. I suggested they register as a venue. A couple of hours later, they had filled out their entire profile nicely, added Tips, Specials, and now the dentist is singing Foursquare’s praises.”By the way you write that it seems this has all happened in about a day? What could possibly be the results achieved in one day?

      1. William Mougayar

        You can look at their profile https://foursquare.com/v/he… I was there yesterday around noon, and it took shape by end of day.”Results” may be a strong word. I said they liked it and signed-up fast. It’s good for visibility. They are a newcomer in the neighborhood, so being on Foursquare might give them a small edge since other dentists aren’t on it in that area.

        1. LE

          Just saw the page.Then I did a search on foursquare for “dentist bolton on ca” and “dentist bolton ca” and the search doesn’t pull them up.I’ve done searches like this in my local area with the same poor results. Like no results. Or crappy non relevant results.FS is definitely lacking in this basic discovery feature on their website..But doing the same “dentist bolton on ca” in google brings them right up as it should.Therein lies the problem with all of these startups.They are just really bad on the small details like this. And there is no active working monitored feedback mechanism and no way for an average user to say “hey why didn’t this work for me?”.Lost opportunity. Why would I try fs again if the past few times I’m not getting any results on the website? (Sorry no need for the app but if I had a good web experience I might consider it.)

          1. William Mougayar

            Good detective work. Maybe the indexing is delayed by a bit. I know that indexing in real-time large amounts of data is not all that straight-forward, but I agree that the “art of the search” is something that Google has mastered to a T, and again- drawing from my experience when we were trying to emulate some things that appear so simple, like type-ahead, disambiguation, boolean choices, relevance vs. recency, etc..- you have to work hard on that stuff because it doesn’t come out-of-the-box.I hope that Foursquare also has Search experts in addition to data scientists.

  6. Peter Cranstone

    Lets hope that the revenue event is at the same place on the event horizon as the inflection point.

    1. fredwilson

      for sure. revenues = real business

      1. Peter Cranstone

        Earnings = real business (and that’s what makes this business so darn difficult)

        1. Ricardo Diz

          I would say revenues = real business, while earnings = good business

          1. Peter Cranstone

            Revenues without cash flow and earnings means debt. Apple has ‘measurable, sustainable, profitable revenue from volume’. Anything less than that metric means you’re not a real business, but you’re trying like hell.

          2. Ricardo Diz

            Not really. P&L, balance sheet, and the cash flow statement are different beasts. Revenue shows up in P&L and means getting cash in-flows (showing up on the cash flow statement / bank account in a time that depends on the sale contract).If I have losses in the P&L, these flow to the balance sheet, but that doesn’t mean debt necessarily. Case in point, most startups finance their losses through initial equity and later equity raises from shareholders.In my view, once you have revenue, you sold something and you have a business. Now is it a good business already? Depends, if I’m already making a profit out of it, it is (simplifying here). If it has losses, then it might be a potential good business, but sure isn’t one yet.

          3. Peter Cranstone

            Well when FS goes public we’ll get to see.In the interim if you use your metrics above with FaceBook and Twitter you see two different businesses. FB is not a google with profitable revenue, so it’s just an ok business which isn’t growing. Twitter is still an unknown – and yet the claim is $1b in revenue. I say great – but show me the earnings – that’s tells me if this is an ok business or a great business.FS has taken a lot of capital, the revenue model should have already been established. It’s not yet which means that the earnings/profitability isn’t established either. Which illustrates why they did a convertible debt round. The investors don’t know what is going to happen and rather than pick a valuation they went with Plan B which is to defer the valuation until there is more ‘meaningful data’.The risk is that FS can’t find that event horizon that generates meaningful revenue with profit. In which case it’s back to the well. And Fred wrote a great post on what that means (when things don’t work out.FS is hovering in that arena – so it’s now or never.

          4. Ricardo Diz

            Good post. I think we’re pretty much saying the same thing now.Indeed, FS needs to find its revenue model, which seems to mean significant changes in its platform. This will surely have an impact on how people interact with it (and that’s mainly the point of the change, really), creating more uncertainty in user engagement, and the business overall.

          5. Peter Cranstone

            Agreed. FS has taken (including this amount) over $100m in funding. That’s a lot to prove a revenue model. Heck I’m looking for funding and have half a billion users of our IP and then won’t look at me until i have over a million in trailing. FS is a long way ahead of me – but with a $100 million of debt (i class liquidation preference as debt)

        2. kidmercury

          siding with peter here. earnings = real business. without earnings your dead. revenue is nice, although i can generate revenue selling $5 bills for $1, i’m pretty confident it’d be an easy sell.

          1. ObjectMethodology.com

            I’m gonna’ have to go with Fred on this one. The first time earnings proves a starup. But, businesses can have revenues without profits. That can change back and forth.More importantly, a business may not turn a profit now to do something *big* for the future.

      2. ObjectMethodology.com

        Nice! That’s better than the blog post (even though it was a good one). A simple grounded point.

  7. kirklove

    There are a few founders out there that really, really impress me and I hope to emulate one day. Dennis is one of them. I’ve never met him (would like to) though comes across as dedicated, driven, visionary, realistic, and yet capable of having a “normal” life and thoroughly enjoying every step along the way. Congrats to him, the team and the investors.

    1. Matt A. Myers

      I hope to be in a similar position to Dennis in the next few years, and I think I can do it. Here’s to vision, patience and persistance.

      1. kirklove

        Whatcha working on Matt?

        1. Matt A. Myers

          Shhhhhhh.. Sooon, sooon.. πŸ˜›

      2. ObjectMethodology.com

        Are you planning to emulate Square?

    2. takingpitches

      So agree. One of favorite posts ever on AVC is long roadmaps, which in part was about, how long and how thoroughly Dennis has been obsessed with “local.”

    3. JamesHRH

      There is a lot to emulate, when it comes to Dennis.i think he is unfairly compared to FB, Twitter & Instagram. I don’t think the Square will be used to that scale. But, it will likely be used to 10-20% of that scale, making it a $5-10 B global business (WAG here).

      1. CJ

        So much more commercial potential in Foursquare though than in any of those others, in my opinion. People are always going places and if the app gives value when you get to those places it’s a win for the consumer, if the consumer (be it the local businesses or the user) can give value back to 4Sq then it’s a win-win.

        1. awaldstein

          Facebook is a non transactional model. No one buys there. Not quite as cut and dry with Twitter, but still basically true.Are you seeing 4sq as a transactional model or a media one or something different? Who’s the payer and who’s the payee in your view of their model?

          1. CJ

            I’m not sure what the model is yet, but with people signaling their intent to buy to the owner while standing in his shop, there has got to be a model there that works for everyone.

          2. awaldstein

            I’m a believer as well.Realistic though that this is really a new area though to crack.

          3. JamesHRH

            They have already had a bang at both coupons and loyalty (I believe). Unless they have that up their sleeve for the next 18 months, all bets are off.Plus, loyalty is already overserved and a lot of retailers hate couponing. That leaves local advertising as the business to disrupt,which noone has been able to achieve, given the dominance of local ad sales forces.I am not saying NO. I am saying it is still wide open.

          4. awaldstein

            Wide open it is.The one thing that the web can do terrestrial businesses and mobile can serve in some instances, is customer acquisition.Merchants just don’t know how to do this. Where repeat customers is the business model, if you can prove customer acquisition you can charge.

          5. JamesHRH

            Agree totally on FB & Twit – they are person to person comm channels. totally non-transactional (but native advertisable).It Make Up New Words Day today, for me.

          6. awaldstein

            A good activity.What I always come back to is that business models haven’t evolved at any pace, where consumer behaviors and communications models are space age to what they were a decade ago.

          7. JamesHRH

            I think money reflects human nature (unchanging) & our habits reflect our innovations (changing).

          8. awaldstein

            Poetic…I’ll think on it and see if it sticks or bounces off of reality;)

        2. JamesHRH

          The biggest issue for 4Sq is proximity.The internet and the storefront are very far apart, today. The retailers are still not sure what the model looks like for engaging customers via smart phones.Yes, 4Sq has won the pioneer battle of the social / mobile / local war & they did it mostly on Dennis’ ability to recruit over $100M in capital. I can name a service that you have never heard of that had 70% of 4Sq’s user base. The company is in receivership – that happens to great products more than people like to talk about, especially pioneering great products.There are more battles to come – that triangle does not have a focal point yet. When it does, that company will not need $100M to prove out its business model (if that is what the CD round is based on).

          1. awaldstein

            Right on about the ‘neighborhood’ gap.My thoughts on this a while back:Searching for neighborhood on the web http://awe.sm/p0eJP

          2. CJ

            Proximity is their biggest asset as well – location information is hugely valuable and their app is the biggest collector of it aside from Google. If they could tie together your shopping history with your location information and create sales customized to you in the moment…now that’s something that would take off. Square has that potential, when they realize it, watch out.

          3. JamesHRH

            I think they have the wrong end of the proximity stick.

          4. Pete Touschner

            I think you are correct here. Fred Wilson would be wise to listen to this and invest accordingly πŸ™‚

      2. ShanaC

        why do you think square will not get to the scale assumed

        1. JamesHRH

          too much work for most consumers, esp w delayed value.

  8. btrautsc

    As I understand it, generally in the seed stage the convertible debt note with a discount misaligns incentives for the early state startup and the angel who is lending them money (greater the increase in cap valuation = less ownership for angel) … So, in this late stage, the company & investors expect a relatively less dramatic increase in value per the next round…

  9. awaldstein

    I’m a fan.I’ve gone in and out over the years and currently jumping back in to rediscover where they are.Cracking local and neighborhood as someone who plays in this area is so hard, so fraught with the unknown…such a huge chunk of the future.We will are in strategy sessions on a mobile approach for theLocalSip…it is time to talk with them about how to wire a vertical enthusiast community cross the city and state, then the country into their system.

    1. laurie kalmanson

      platforms/networksi want X; who has it? applicable to wine, applicable to anythingit’s like putting something out for bid.haven’t seen littorai in a long time

  10. Zach Stevens

    I think it’s a win-win as well. If the management team doesn’t experience dilution, they’re more incentivized to work harder to create value, right?In Foursquare’s case, I would think that they’re already fairly diluted, seeing as how they’ve already raised $71.4m in equity financing.

    1. mlr3000

      They experienced the dilution with this, they just don’t know how much until the next round of financing. It’s more accurate to say, “they felt the dilution should be X, investors felt it should be a multiple of X” and everyone agreed to postpone the figuring out of that number. Investors — to their credit — take a bit of risk here, but not much. Since it’s debt, in a sale of the company, their preference will be absolute over all classes of equity.

      1. Dasher

        Obviously investors are thinking that the company can fetch at least $41M if sold in the future. That is a safe bet. The data they have itself would be worth a quite a bit more than that.

  11. Ji Eun (Jamie) Lee

    Thanks so much for this post, Fred! I really admire your ability to breakdown complex financial concepts into easy-to-understand events with consequences for stakeholders.

  12. jason wright

    what will be done with the $41 million of capital?does this now allow the founders to ride nicer bicycles to work in the morning?

    1. Matt A. Myers

      What’s wrong with their bikes now?

      1. jason wright

        nothing I’m sure, but if it means more people riding more bicycles then that’s a very fine thing πŸ™‚

    2. Matt A. Myers

      I know what I’d do, curious too of what they have planned though.

    3. Aaron Klein

      I can guarantee you the founders aren’t taking a dime out on this one. This is $41MM to build proof of a real business model that can drive real revenue growth.I’ve never been able to get into the product despite 4-5 attempts. But I can’t do anything but pull for these guys to succeed.

      1. kidmercury

        they already cashed out when they had their excessively high valuation, which is the smart thing to do from a personal perspective. http://techcrunch.com/2010/

        1. Richard

          Transparency

        2. ObjectMethodology.com

          That’s the kind of stuff everyone wishes for. You get $20M and you put $5M of it in your pocket. Awesome!The article doesn’t say if Albert took some personal liquity before USV did.

          1. fredwilson

            neither Albert nor USV has taken any money out of Foursquare

      2. arustgi

        “$41Million to build proof of a real business model” – Completely Speechless..

      3. jason wright

        everyone deserves a little treat now and then.

    4. fredwilson

      build the sales team from 10 to 40. build the data team to drive even more value to users. and pay the rent and payroll until revenues catch up to expenses

      1. awaldstein

        Curious…they have a chief data miner or scientist?Really interested in this role. The new super hero in many ways.

      2. Balu Chandrasekaran

        I’ve spent a lot of time with small biz owners and still continue to do so. They’re tired of the same old salespeople hitting them up constantly for business. I cannot tell you how much hatred/grudging acceptance there is in the small biz community of the sales folks at Yelp.Most small biz owners don’t get 4SQ’s potential role in helping them grow their business. I think what’d be more effective would be a online-offline marketing campaign that would educate small biz owners on 4SQ.Is 4SQ considering a marketing campaign aimed at small biz owners? (in the same way that Square has captured their attention). Here’s me hoping.

        1. Balu Chandrasekaran

          Maybe the sales people are for larger customers, not SMB’s. I may have misunderstood. Either way, I hope 4SQ launches a marketing campaign aimed at small biz owners.

  13. Paul Sanwald

    I just want to say that’s it pretty awesome to have read previously about convertible debt on MBA mondays, and then read this followup real world case, illustrating where it makes sense. It really drives the concept and its practical application home for me.

    1. Matt A. Myers

      Thursday is the new Monday.

      1. fredwilson

        maybe

        1. Dasher

          Everyday is Monday – School is open that is πŸ™‚ Thanks Fred.

        2. Matt A. Myers

          I think it’s being well-received anyway πŸ™‚

  14. howardlindzon

    bullish. great leaders, teams just sometimes need the capital. we need big bets like this.

  15. Max Yoder

    Cool. This helps me. Thanks, Fred.And congrats on the forward motion.

  16. kidmercury

    none of this solves the problem that they raised too much money at the wrong price; all it does is delay the solving of that problem, and is probably the biggest reason an equity round cannot be done now. i’d probably do the same thing if i was in foursquare’s situation since i expect US equities to rise, although i think investors are basically being asked to foot the bill here for a misvaluation, since they always had to pay too much. obviously that is my subjective take, clearly investors were comfortable with the price.

    1. ObjectMethodology.com

      “none of this solves the problem that they raised too much money at the wrong price”But it’s a great topic for AVC to cover and gives us a nice real example. Are you stuck in yesterday’s mode? lol

      1. kidmercury

        just adding my thoughts, which i thought would add to the discussion.

        1. ObjectMethodology.com

          Cool. I though for sure you’d notice my Lunatic Fringe lyrics in yesterday’s post and comment about them.

    2. William Mougayar

      Sometimes things take longer than you planned for. The best lesson here is that the existing VC’s were there to support them. That’s key, and it’s golden. Not all VC’s would have done that.

    3. Ricardo Diz

      Well said.

  17. RichardF

    I really like the latest android app and the search and curation direction 4sq are taking. I have only returned to it lately, in fact this post drove me to see if 4sq had reached the little known Austrian ski resort I am staying at the moment and to my surprise it has, so world domination may be on the way!

  18. William Mougayar

    Quick Q from a transactional point of view. In a case like this, does this note take liquidity preference over anything prior?

  19. Mike

    Amateur question but does convertible debt specify the ratio of shares you can convert at? If not, then aren’t you taking a big risk as an investor by investing money in the company now but letting someone else set the price that your debt will convert at later?

    1. PhilipSugar

      Letting somebody else set the price is the whole point. If they get a great valuation your debt converts at less shares but your existing shares are worth more. Exact opposite at low valuation.

      1. PhilipSugar

        Which by the way is exactly why convertible debt sucks if you don’t own underlying shares. I.e. it is a startup. You get the downside but no upside.

    2. fredwilson

      no and yes

  20. Doug Knittle

    From the chatter on the street Foursquare was looking at a down round, convertible debt is a stay of execution, if the team executes the next round valuation will be in their favor, if not, they face huge dilution and maybe a complete washout of the teams equity? Lets all root for these guys to find that rev stream!

  21. Tom Labus

    It gives them time the most valuable of all start up commodities.

  22. Bo Sartain

    I think convertible debt is also very useful for founders’ investments in their own companies at the earliest stages before they raise outside capital from angels and VCs. It can be quite useful to avoid putting a valuation on the company too early for pricing stock options, and, when the founder convertible notes convert, the founders will get credit for their investment and have the liquidation preference to get their own money out first along with the investors’ money, in contrast to their β€œsweat” equity that sits behind the liquidation preference.

  23. takingpitches

    I was researching how the Silver Lake Waterman portion of the round, so-called “venture debt” worked, and Google, appropriately enough, sent me to a MBA Mondays post on the topic. Full circle!http://www.avc.com/a_vc/201

  24. David Petersen

    I got bored of checking in on Foursquare about a year ago. The discover stuff sounds promising though, so I reinstalled it today. I’m already kinda impressed with the recommendations.I for one am looking forward to having computers make all my decisions for me πŸ™‚ or at least solve my insomnia (I got Jawbone Up for that).

    1. fredwilson

      yessssssssss

  25. ShanaC

    I have to say, I find it super-surprising that they aren’t making money off their internal search engine because people can’t figure out it is there. It is an incredibly good tool to see what your friends have done when you want to do the same thing (particularly with food)

  26. Capitalistic

    Interesting. Great post.

  27. howardlindzon

    I still do not use foursquare. I dont think it matters anymore because I live on a small island. I use Stocktwits and Twitrer and email to ask questions that I need answers to in real time or I go to Google to search.What I feel is the opportunity is a Twitter 411. I want other people to be able to piggyback off my knowledge or boradcasting strength.There is also way too much slippage in the system with Twitter. I ask for a ‘Middle Eastern’ food reco in Santa Monica as I enter Santa Monica on the freeway. i get 20 reco’s quickly and triangulate the most reco’d from the people that most likely would know. I go to the restaurant…the owner has no idea how I got there, and no way to know how I could help him if I loved the food. All this currency that all the parties used that put my butt in that seat and yet …Slippage.Tons of opportunity and I doubt anyone figures out the magic. That said, it’s worth continuing to try from an entrepreneur and VC standpoint. Feels possible for sure.

  28. Allen Rice

    @ John, that page you mentioned is broke and might need a repair. Good info!