Nivi · May 29th, 2007
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As usual, we’ve received many mind-expanding comments—here are some of the very best. The very lucky winner of a mug for great contributions in the field of venture hacking is indicated with a subtle ball of fire.
Dead simple equity agreements
“I’ve done early angel preferred stock financings where the angel Series A only had a liquidation preference and there was a contractual provision that forced to company to give the angel Series A all other investor rights that would eventually be given to the “real” Series B (adjusted for price-related terms). The Series B may have issues with giving the Series A the same level of rights, so the Series B may condition the Series B financing on the Series A rights being something they can live with.”
A caveat: this is not the same as an equity financing with “standard” or “vanilla” terms. Yokum is talking about preferred stock with no rights other than a liquidation preference. So-called “standard” terms are almost always in the investor’s favor.
The benefits of convertible debt
“First, don’t underestimate the benefit of simplicity, convertible debt is a lot cheaper and quicker to put in place than an equity structure, even with dumbed down seed / angel terms. Also, if you’re raising the money $50-100k at a time, you don’t really have one person to negotiate terms with, so the fewer terms the better.
“Regarding valuation vs. no valuation, don’t forget one benefit angels are getting either way is access to the company. The door is typically shut at Series A. I don’t think it makes sense as an angel to push too hard to put a price on the company at the seed round. For one thing, its possible (and not entirely uncommon) to overpay, which is awkward for the company and the angels. A risk premium to the Series A in the 10-40% range should be adequate compensation.
“I think complex discount / cap structures can be more trouble than they’re worth. As noted, at the extreme you are pricing the company, they complicate and increase the cost of putting the round in place, and based on some experience, VCs just seem to hate paying more for a Series A share than the seed investors. Warrant coverage provides the same risk premium with a lot less friction.”
Raising debt from friends and family
“We just did a convertible debt offering for our seed round and raised about $125k about 6 months ago. It was easy and painless. The investors were mostly friends and family and did not really want to bother negotiating a term sheet for an equity round. In fact, we didn’t spend nearly $10k for our debt deal, since there were boilerplate agreements without any negotiating. Our attorney just sent us the agreements, explained the mechanics to us, and we went around collecting checks and getting the docs signed…
“The terms were straight-forward and we didn’t have to make any real concessions. We did the deal with a 10% coupon (equal to a 10% conversion discount if security held for 12 months) which is paid in stock at the Series A. Based on what I’m hearing, we got a pretty good deal. However, we lost a few other potential investors who wanted better terms with a real conversion discount at 40%. In the end, we probably left about $200-$300k on the table by sticking to our original terms. The bottom line for us was that non-friends/family wanted better terms to protect their investment. Friends and family were happy with the basic terms to help us out and participate in any upside. We call this type of capital “love capital” and it’s probably some of the cheapest around. Definitely look for it if it’s available.”
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