Comments on: Keep your Series A options open if you raise debt

By: Nivi

Nivi — Fri, 15 May 2009 03:08:05 +0000

As long as the company makes significant progress after raising the debt, the pre-defined valuation shouldn’t anchor the valuation of the Series A.

By: MSJ

MSJ — Thu, 14 May 2009 20:18:16 +0000

Nivi,

What about Special Conversion, where if there is no Series A raised, the note holder must convert at a pre-defined valuation. I’m concerned that establishing a valuation now (albeit “worst case”) might decrease our leverage when negotiating valuation with VCs at Series A. On the other hand, I don’t want to remove the protection that this clause give us by not having to pay back the note at Maturity. Thoughts?

By: Nivi

Nivi — Thu, 21 Jun 2007 22:39:24 +0000

Feel free to ping me and Naval at nandn at venturehacks dot com regarding your fundraising. We're both investing and we would be glad to take a look. This ROFR is onerous. This is what you would give to someone whom you expect to lead the next round. This is also going to screw up your valuation in the next round: the new Series A investor will pay $2M for 20% of the company instead of $4M for 20% of the company. This halves your pre-money! If you accept this term you're going to have all the issues we described in this article with respect to ROFRs and in our attractive debt article with respect to insiders who want to increase their percent ownership in the next round. VCs usually only ask for the right to do their pro rata in the next round. So if a VC owns 20% of the post-money, he has the right to invest 20% of the capital raised in the next round. Furthermore, the good ones make it a policy to take exactly their pro rata in the next round so they don't send signals. (Angels and smaller funds aren't necessarily expected to do their full pro rata since they have limited funds.) What are your angels' policy? If you don't have enough competition to get rid of this term, I suggest giving the angels 20% - 100% warrant coverage. This lets them participate in the next round in line with their participation in this round but doesn't really send any signals if they participate or don't participate in the next round.

By: J Lyons

J Lyons — Thu, 21 Jun 2007 21:04:32 +0000

I expect to close a convertible debt round with a group of reasonably sophisticated angels. One of the provisions they want to include is their ability to invest up to $2MM in the series A. I expect that the series A will be a total of $4MM (excluding the notes converting). Will I have problems attracting potential series A investors with this provision — if the angels opt to invest the $2MM, they would be the largest holder of series A (when accounting for the conversion of the debt).

By: Nivi

Nivi — Sat, 19 May 2007 23:41:40 +0000

Knox, I meant follower in the sense that angels are not going to lead the Series A. They will follow a leader in the Series A if they want to re-invest.

By: Knox Massey

Knox Massey — Sat, 19 May 2007 21:14:34 +0000

Nivi writes: “Angels are followers…”

Really? They certainly weren’t when they wrote the first check to the company….

By: Suzie Dingwall Williams(Venture Law Lines)

Suzie Dingwall Williams(Venture Law Lines) — Wed, 09 May 2007 18:53:02 +0000

Here’s a new problem for me, that has cropped up with my clients that have US investors: what happens if your investor is nearing the end of his current fund and isn’t having much luck with the next fund raise? Other VCs can be reluctant to partner in a Series B or C round with a VC who may not be able to participate in further follow on rounds. Especially if the existing VC has a ROFR – if he/she doesn’t invest it underscores the weakness of the current investor. The ROFR also allows him to draw out the process and hedge for time. If someone is more than halfway through their current fund, I woudl take the arguments you’ve placed in your ost and apply them with extreme prejudice.

By: Nivi

Nivi — Wed, 09 May 2007 18:47:22 +0000

Mark, Brad,

I tried to clarify the writing:

Raising convertible debt from angels usually leaves your Series A options open. Why? Angels send a positive signal if they want to re-invest in the Series A, but they don’t send any negative signals to your prospective investors if they decide to pass. There are many simple reasons why an angel may not re-invest in the next round.

VCs send a strong negative signal if they say they are not going to re-invest as you start raising your next round.

Angels are followers, if the terms of the next round make sense, they will join. As you start raising your Series A, nobody is looking to the angels for any specific signal that they are going to re-invest in the next round since there are many simple reasons an angel may not re-invest. Angels are not expected to maintain their pro rata like a VC.

Getting bad references from your angels is obviously another story…

It’s tough to articulate this in detail at the beginning of the article since the purpose of the article is to describe these mechanics. These ‘game theory’ articles are a pain in the ass to write!

Let me know if you think we’re off the mark.

By: Brad Feld

Brad Feld — Wed, 09 May 2007 11:37:28 +0000

Mark – I agree. Whenever I invest as an angel, I typically maintain my prorata in future rounds unless explicitly asked not to in order to make room for the new lead VC to take as big a piece of the round as they can.

By: Nivi

Nivi — Tue, 08 May 2007 23:09:25 +0000

Great point Zach. "ds" also listed some of the benefits of debt in a comment.