“Startup Investing: What You Need to Know About Convertible Notes (2nd Edition)” focuses on using convertible notes as a pre-Series A deal structure, so for the purpose of this report, assume the following:
We’ll discuss qualified financing in Part 5. For now, all we need to know is that qualified financing is the minimum amount the company must raise in order to trigger the debt-to-equity conversion.
This is an excerpt from a special report on using convertible notes as a pre-Series A deal structure. Download full report at “Startup Investing: What You Need to Know About Convertible Notes (2nd Edition).”
What Happens in the Valley Stays in the Valley
First, it’s important to establish one fact: Every deal is different, and no one term is universal. What works in Silicon Valley might not be applicable elsewhere.
Photo: Boon Lee
Silicon Valley is the veritable Hollywood for startups. Everyone is drawn to the glitz and glam of Silicon Valley, but what happens in the Valley hardly reflects the overall reality.
Silicon Valley investors comprise only a small percentage of the angel market, just as Hollywood celebrities make up just a tiny percentage of the national population. Additionally, many Valley investors who are dubbed by the media as “super angels” aren’t really angels; they’re micro or seed venture capitalists who manage small funds and invest other people’s money, in addition to their own.
This report’s primary focus is to present commonly used terms that are negotiated by experienced angels and angel syndicates in life beyond Silicon Valley.
Case In Point: Yuri Milner, SV Angel and Y Combinator
The much-talked-about Start Fund is the joint venture between Russian billionaire Yuri Milner and legendary Valley investor Ron Conway’s angel fund, SV Angel. As you might have heard, the fund was created to offer Y Combinator startups a US$150,000 convertible debt with no cap and no discount. This is an extremely entrepreneur-friendly deal. [5]
The piece spread like wildfire when TechCrunch broke the news in January 2011. Inexperienced investors and young entrepreneurs began to speculate about the impact this might have on the venture investing marketplace, i.e., “other investors can’t compete for deal flow as they won’t be able to match the terms”; “entrepreneurs will start asking for convertible deals with no cap and no discount,” and so forth.
But as Roger Ehrenberg, managing partner at the early stage VC firm IA Ventures, rightly asserts, “Start Fund: No big deal. Business as usual.” [6]
Ehrenberg admits that Silicon Valley is great; Y Combinator is great; and Milner and Conway had “done something bold and surprising.” However, he stresses that “they DO NOT represent anything remotely resembling the investable universe.”
He continues, “We’re talking about a very small segment of the market representing a tiny amount of the angel and seed-stage venture capital deployed in companies across the U.S.” Therefore, “the fact that Start Fund is providing cheap capital [to] 43 companies, while interesting, is hardly going to distort the market for angel financings.”
Ehrenberg adds that there is a wealth of worthwhile seed companies in which to invest outside of Y Combinator and the Valley, even though “the tech press would have you believe otherwise.” He quips, “Until [Milner] and friends open their checkbooks and start providing this offer to every startup in the U.S., I’m really not sweating it.”
Even if someone were to offer every startup in the U.S. such entrepreneur-friendly terms, “rationality will inevitably re-enter the market, because over time, risk and reward must be priced properly.” Ehrenberg maintains that “receiving debt returns for taking equity risk is not sustainable” and says it’s just “an interesting move by a rich (and smart) maverick in a small segment of the startup market. Period.” The joint venture and the Y Cobminator deal is the exception, not the norm.
This is an excerpt from a special report on using convertible notes as a pre-Series A deal structure. Download full report at “Startup Investing: What You Need to Know About Convertible Notes (2nd Edition).”
