MLA Convertible Debt For Early Stage Investments
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This content was delivered during a lunch and learn session on July 3, 2013 by Dr. Richard Reiner.
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MLA Convertible Debt For Early Stage Investments
- 1. C O N V E R T I B L E D E B T
- 2. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels AGENDA WHAT? CONVERTIBLE DEBT PARAMETERS TYPICAL TERMS WHY? TROUBLE IN PARADISE PRICE CAPS SUMMARY
- 3. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels CONVERTIBLE DEBT Paul Graham (Y Combinator) tweeted in 2011: “Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”
- 4. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels WHAT? • Debt (typically a promissory note) issued by an investor to a startup… … where the principal and accrued interest convert into equity under certain conditions • Used when the investor’s intention is ultimately to own equity, rather than to earn a return through interest payments
- 5. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels PARAMETERS • $ amount • Interest rate • Conversion upon next financing • Minimum trigger amount • Discount or warrants • Optional: price cap • Conversion price if no next financing • Conversion on exit before financing or maturity • Merger premium (multiple) • Maturity date and repayment terms • Secured? Against what? • Board rights • Information rights • Pre-emptive rights on next financings • Right of First Refusal • Co-sale rights • Protective provisions • Fancy stuff, e.g. discounts that increase over time
- 6. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels TYPICAL TERMS • Conversion into Series A preferred • Median conversion discount: 20% • Median interest: 5.5% • Median maturity: 18 months • Merger premium: 2x (Fenwick and West, 2012) • Secured against company IP • No board set
- 7. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels TYPICAL TERMS - DETAILS Fenwick and West, Seed Finance Survey 2012 http://www.fenwick.com/publications/Pages /Seed-Finance-Survey- 2012.aspx?WT.mc_id=2012.SEED_BK_email
- 8. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels WHY? • Punts on negotiation over valuation and many pref share terms • Simplifies legals • Simplifies and speeds up negotiation over terms • Lower transaction costs • Some angels will even do them without legal counsel • Avoids taking on liabilities of Directors and Shareholders (because you aren’t one) • As a creditor, near the front of the line in case of adverse liquidation (after employees)
- 9. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels TROUBLE IN PARADISE • Can be a bad deal for angels • Does a 20% discount sufficiently compensate for a year or two of additional risk vs. the Series A investors? • Series A investors will generally veto higher discounts, may sometimes resist even 20% • Misaligned incentives vs. founders on Series A valuation • Founders want it high • You want it low
- 10. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels PRICE CAPS • Solution proposed for the risk/reward and alignment issues: conversion price • Sets a maximum conversion price, e.g.“20% discount to Series A, not exceeding a price per share based on a valuation of$5M” • Most sophisticated angels post 2010 will not do uncapped converts • Still not perfect • Valuation negotiation with founders has come back into the deal • Founders have sometimes received the (bad) advice to refuse capped converts • This has become a contentious enough issue that early- stage convert deals have actually begun to decline in number again after peaking in ~ 2011 • Some VCs look at the cap and see it as a price ceiling for the A round!
- 11. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels SUMMARY • Cheaper and easier, but: • Without a price cap, not fair to angels • With a price cap, not quite as easy • Capped converts are often a good choice • But there are also good alternatives: simplified standardized equity terms • Series Seed (Fenwick & West) • Series AA (Y Combinator) • Plain Preferred (Founders Institute) • TechStars model documents • Etc.
- 12. www.mapleleafangels.com | info@mapleleafangels.com | 416.646.6235 | @mapleleafangels CONTACT