This presentation was given by Dave Young (Cooley) on 9/19/13 for Angel Bootcamp, a one day conference for angel investors to learn strategies and perspectives from active investors in Los Angeles.
3. www.cooley.com
Convertible Notes
Investment that is effectively “parked” as debt until
valuation is determined
Converts automatically to equity upon “Qualified
Financing”
Discount: 10 to 30% (20% most common at early stage)
Interest: 5 to 8%
Maturity Date
Typically Unsecured
4. www.cooley.com
Convertible Note Origins
Short-term bridge to next equity round
Advantages for company:
Quicker/cheaper
Avoids setting valuation
Advantages for investor:
Quicker/cheaper
Avoids setting valuation
Assurance of “VC negotiated bells and whistles,” but at discount
Downside protection
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Convertible Notes: Evolution at Early Stage
Amounts Increased to be Round of Financing not Bridge
Alternative to seed equity round
Company can use proceeds to scale valuation prior to next round
Investor Responses
Capped Valuation (protection, or proxy for valuation?)
Change of Control Provisions
Optional conversion at valuation cap or other fixed price
Multiple return on investment (2x most common)
Unlimited upside vs. downside protection (but consider acqui-hire
situation)
Optional Conversion into Common or Preferred upon maturity at pre-
determined price
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Convertible Notes: Low Valuation Caps
Investor has unlimited downside protection
Company fix: Do a priced preferred stock round
Investor can receive multiple liquidation preference
Company fix: conversion into shadow series, or conversion of
discount into common stock
Funky stock option pool math
Company fix: adjust formula
Interest Rate can be viewed as windfall to investor
Company fix: Low interest rate (IRS imputed rate) if low cap
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Preferred Stock Financing
Valuation:
15 to 25% for $1 million?
Size of Raise is Critical
Small investment may justify lower valuation than industry norms
Transaction Documents:
“Series A” forms
Short-form Seed forms
Caution: Investor-favorable terms can backfire
This dynamic simplifies deals
8. www.cooley.com
Preferred Stock Financing Terms
Liquidation Preference (participating or non-participating)
Dividend (cumulative or non-cumulative)
Board Seat
Protective Provisions
Anti-Dilution (broad-based weighted average)
Redemption
Right of First Offer
Registration Rights
Information Rights
Co-Sale Rights