Comments on: Advantages of Convertible Debt in Seed Financing http://www.vcreadylaw.com/blog/2009/11/13/advantages-of-convertible-debt-in-seed-financing/ Is your business VC Ready? Wed, 27 Oct 2010 17:21:55 -0700 http://wordpress.org/?v=2.8.4 hourly 1 By: Scott Sneddon http://www.vcreadylaw.com/blog/2009/11/13/advantages-of-convertible-debt-in-seed-financing/comment-page-1/#comment-596 Scott Sneddon Sat, 14 Nov 2009 21:14:52 +0000 http://vcreadylaw.com/blog/?p=125#comment-596 Agreed, very timely. Was just at a TCN breakfast on Friends & Family financing and heard an entrepreneur describe how he funded his company in the early days. He wrote a single convertible debt agreement with no discount on conversion. Then, for early investors, he issued warrants for 20% of the investment amount, for those that signed on later he issued 15% warrants, and for the final group before his Series A, he offered 10% warrant coverage (all the terms of the debt stayed the same for all of thee investors) That seems like it has two practical advantages from the entrepreneur's perspective. 1) It allowed him to easily reward the early investors for taking the additional risk without each set of investors having a slightly different note agreement. 2) It made it easy for some of his investors to convert the note into cash (to cash out at the Series A) while still having a small investment in the firm (they feel like they still have a small piece of the upside). For many family investors, this what they really wanted. They didn't want their total investment tied up in illiquid shares waiting for an exit, but did want to "take the ride" at least a little. Thanks guys, very useful, as always. Agreed, very timely. Was just at a TCN breakfast on Friends & Family financing and heard an entrepreneur describe how he funded his company in the early days. He wrote a single convertible debt agreement with no discount on conversion. Then, for early investors, he issued warrants for 20% of the investment amount, for those that signed on later he issued 15% warrants, and for the final group before his Series A, he offered 10% warrant coverage (all the terms of the debt stayed the same for all of thee investors)

That seems like it has two practical advantages from the entrepreneur’s perspective. 1) It allowed him to easily reward the early investors for taking the additional risk without each set of investors having a slightly different note agreement. 2) It made it easy for some of his investors to convert the note into cash (to cash out at the Series A) while still having a small investment in the firm (they feel like they still have a small piece of the upside). For many family investors, this what they really wanted. They didn’t want their total investment tied up in illiquid shares waiting for an exit, but did want to “take the ride” at least a little.
Thanks guys, very useful, as always.

]]> By: Mark Loranger http://www.vcreadylaw.com/blog/2009/11/13/advantages-of-convertible-debt-in-seed-financing/comment-page-1/#comment-592 Mark Loranger Fri, 13 Nov 2009 20:40:22 +0000 http://vcreadylaw.com/blog/?p=125#comment-592 Great article guys. Provided that the note holders don't plan on being heavily involved (financially) in future rounds, convertible debt is a great way to go. You mentioned that the discount rate typically range from 20-40%. I'd also point out that the carried interest rates are usually between 6-10% and the term of the note is usually 1-2 years, sometimes with a "step up" in discount rate as the term gets into year 2. These are all "levers" in the negotiation with debt investors - much simpler than equity provisions but still very important! Good stuff! Great article guys. Provided that the note holders don’t plan on being heavily involved (financially) in future rounds, convertible debt is a great way to go.

You mentioned that the discount rate typically range from 20-40%. I’d also point out that the carried interest rates are usually between 6-10% and the term of the note is usually 1-2 years, sometimes with a “step up” in discount rate as the term gets into year 2. These are all “levers” in the negotiation with debt investors – much simpler than equity provisions but still very important!

Good stuff!

]]>