Comments on: Why you should price your venture round

By: John Hammer

John Hammer — Sun, 03 Feb 2013 22:56:00 +0000

One does not see enough discussion on convertible notes. As a former investment officer in a community development corporation, I did a couple dozen notes. It is an ideal instrument for organizations that are not in the business of valuation or maximizing return. It might be appropriate for some strategic investors as well.

IMHO, it is not at all appropriate for V.C.s or individual investors and it may harm the company as well. For one, it leaves money on the table. If the investor receives a 20% discount to a priced round and the money raised by the note increases the theoretical valuation by a factor of two, risk is not compensated for.

I have seen notes piled on top of notes. This can harm the capital structure and it is complicated to calculate a pre-money valuation for a priced round. I received a company term sheet last year that placed a pre-money valuation on the company that did not include the note conversion. It sounded pretty good until one looked at the details. In this same deal, the management shares/options got heavily diluted as the notes gave them an inflated sense of ownership.

As a private investor, we do not do convertible notes.

By: Mark MacLeod

Mark MacLeod — Thu, 17 Jan 2013 01:24:00 +0000

Hey Adam, I agree. Since when was it a good idea to take the “easy” way. Being cheap or easy is not an argument that works with me. You should always do what’s best for the long term.

By: Adam Lieb

Adam Lieb — Wed, 16 Jan 2013 22:14:00 +0000

I have not found convertible notes to be far and away cheaper than priced rounds. The biggest push we hear for notes is that they are “cheap” to get done on the legal side of things. If they aren’t negotiated sure they are cheap, but so are equity rounds. I agree completely about “locking in” your price, times ARE good.

By: Mark MacLeod

Mark MacLeod — Mon, 14 Jan 2013 01:46:00 +0000

To be clear what I’m saying is use the note in this raise. Say you’re raising $500k do it by notes that convert under pre-defined terms once you hit 500.

By: Boris Mann

Boris Mann — Mon, 14 Jan 2013 01:17:00 +0000

Yeah, that’s my default for dealing with notes. IMHO you shouldn’t use a note if you don’t already have a good idea when / where your next raise is coming from. We see the note and then no more raises in Canada too often.

So, yes to priced rounds

By: Mark MacLeod

Mark MacLeod — Mon, 14 Jan 2013 01:09:00 +0000

In my limited experience with this the rolling clause sounds better than it actually is. It creates some tension between investors. If I pay 5% more because I’m a week or a month later than someone else that can be a problem.
If you want to try it with a priced round, best off doing a 2 step process: raise a note with a cap but where the trigger to convert is getting to $x on this round, not the next one. Use progressive discounts to incent early investors.

By: Boris Mann

Boris Mann — Mon, 14 Jan 2013 00:12:00 +0000

The converse of your statement should probably be said more strongly: when you are raising your first bits of money, it is often the case that you are raising less than 1 year of runway.

I think the “rolling raise” aka continuous raise is something that I’m going to investigate more deeply WITH priced rounds. Mark, any thoughts/experience on how that might be accomplished?

By: Mark MacLeod

Mark MacLeod — Sun, 13 Jan 2013 12:04:00 +0000

I did not say notes should never be used. The post is just pointing out some downsides to notes that most people don’t consider. They have their place in the financing mix for sure.

But I don’t agree with seed stage companies raising > 1 year of cash by a note. Most seed stage investments fail. If you limit your upside going from seed to series A (which a note does), that forces the investor to do less seed deals and more later (de-risked) deals. That will have long term negative repercussions on the ecosystem.

By: Mark Organ

Mark Organ — Sun, 13 Jan 2013 03:07:00 +0000

VC admits that convertible notes are favorable to founders, then proceeds to tell founders why they shouldn’t want them. It appears to be disingenuous to me.

Convertibles are a crucial tool for founders and early on in a company’s life should likely be employed 100% of the time if it is possible.

Whatever minor downside that is presented here is so miniscule compared to the benefits. The #1 benefit is the rolling close and variable terms. This allows the founder to raise a round over months and not have to herd the cats on a valuation, and employ the cash as it is received. This generates a lot more progress before raising the priced round. This is HUGE.

By: Heisler PR

Heisler PR — Thu, 10 Jan 2013 18:43:00 +0000

Corporations considering a financing by way of issuing convertibles also need to keep in mind that they may also be limiting their upside.