Is It Important To Understand Convertible Debt Terms?
Recently, several entrepreneurs and investors have asserted to me that they don’t think the terms on a convertible debt deal matter much. I was perplexed by the statement and asked each of them to tell me more. In every case, the person hadn’t really thought through the issues. Rather, they were just spouting what they believed was conventional wisdom about terms for seed deals.
In one of the entrepreneur cases, I explained how it was likely that they were going to be on the wrong side of the valuation discussion in the next financing based on one of the terms. In one of the investor cases, I explained the difference between a 2x return and a 15x return – using a real example – based on the way the note was written. And in a third case a separate potential angel investor in the deal brought up a specific term that was important to him that addressed a real concern.
We rarely do convertible debt at Foundry Group – we much prefer to do equity rounds, even at the seed stage. However, many of the seed rounds done in TechStars are done using convertible debt as are many financings of less than $1m. So, if you are an entrepreneur or seed investor, I think it’s important to understand how convertible debt works and what the impact of various terms are.
In Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, my partner Jason Mendelson and I touched on convertible debt but didn’t go into much detail on the specific terms. A number of people have asked us about them since the book came out so we’ve started a Convertible Debt series on AsktheVC. The first three posts are up:
- Convertible Debt Series
- Convertible Debt – The Discount
- Convertible Debt – Valuation Caps
There are nine posts in the series – coming out every Tuesday and Thursday until we are done. If you notice anything confusing, or incorrect, please comment and/or ask questions so we can clarify and/or fix.
If you can’t wait for the full series, take a look at the annotated term sheet for a convertible note on the TechStars site (also available on the AsktheVC Resources page.)