Nivi · May 30th, 2007
Summary: Convert your debt into equity if you can’t pay it on time. Determine your lender’s return if you sell the company early. Reserve the right to raise more debt. Finally, reserve the right to amend the debt agreement.
Previous convertible debt hacks have discussed
- The benefits of debt in a seed round
- The economics of debt vs. equity
- Making your debt attractive to investors
- Keeping your Series A options open
This article collects 4 convertible debt microhacks you can use to supersize your convertible debt.
Convert the debt into equity if you can’t pay it on time.
Your Series A financing may not occur before the debt comes due. In that case, the company should have the right to
- Pay the debt and interest back, or
- Convert the debt to common or preferred stock at a predetermined valuation.
Note that the company makes the decision to convert the debt to equity—not the investors. This term lets the company avoid defaulting on the loan. See this great article by Yokum Taku for more details.
Determine your lender’s return if you sell the company early.
The company may be acquired before the Series A. In that case, the debt holders should have the right to
- Get their money and interest back, or
- Convert their debt to common stock at a predetermined valuation.
The lender chooses between these two options at the time of sale. This term simulates the liquidation preference of preferred stock. You can use the same valuation that you negotiated in the microhack above.
Reserve the right to raise more debt.
If you are raising $500K in debt, you should reserve the right to use the same documents to conduct subsequent closings up to some cap, say an additional $250K of debt.
Many debt agreements don’t require you to get the current lender’s permission to raise more debt in the future. But it is better if your current debt investors clearly understand this possibility. And it will be cheaper if you can use the same documents to close the additional debt.
Reserve the right to amend the debt agreement.
The company and a majority of the lenders should be able to amend the debt agreement and make the changes binding upon the other lenders. This is much easier than getting agreement from every single debt investor.
This term is especially useful if one of your angels is inexperienced or malicious. Without this term, he may try to negotiate a better deal when you request the amendment.
What are your debt microhacks?
Use the comments to share your experiences and questions regarding debt microhacks. We’ll discuss the most interesting comments in a future article.