The Good, the Bad, and the Ugly of Convertible Debt
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Transcript of The Good, the Bad, and the Ugly of Convertible Debt
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Convertible Debt December 12, 2013
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Today’s(Experts(• Ben(Li3auer((
– Advisory(Board,(The(Capital(Network(– Member,(Walnut(Ventures(– Member,(Boston(Harbor(Angels(– Director,(Several(Startups(– Former(Entrepreneur(– Geek((selfLdescribed!)(
• Robert(Bishop(– Partner(Goodwin(Procter(LLP(– Over(17(years(experience(represenTng(venture(capital(firms(and(high(growth(
companies(– Founding(team(member(of(the(Founders(Workbench(
(
ConverTble(Debt(
(Ben(Li3auer(
[email protected](vizibility.com/li3auer(
@li3web((
Robert(Bishop([email protected](
((
Structure(of(an(Equity(Deal(
• Company(and(Investors(agree(on(a(“preLmoney(valuaTon”((PM)(which(leads(to(a(price(per(share(
• Investors(put(in($X(• Investors(then(own:(X(/((X(+(PM)(of(the(company(
Example:(PM(=($1M(X(=($0.5M(Investors(own(0.5/1.5(=(33%((Remember:(New(issuance(NOT(transfer(
What(about(ConverTble(Debt?(
• Many(seedLstage(companies(use(an(instrument(called(ConverTble(Debt.(Huh?(
• ConverTble(debt(is(not(tradiTonal(bank(debt(• Converts(exist(for(several(reasons(– Investors(and(Entrepreneurs(find(it(hard(to(agree(on(a(PM(valuaTon(
– SomeTmes(quicker(and(cheaper(to(document(than(equity(deals((
– May(allow(for(“rolling(close”(accreTon(of(investment((
ConverTble(Debt(provides(OpTonality(
• Conver'ble*Debt*=((usually)(unsecured(debt(obligaTon(of(the(Company(that(may(be(converted(into(equity(of(the(Company.((
(• Conversion*Trigger*=(Qualified(Financing(usually(at(some(
minimum(amount(of(funds((ex.($500,000)(
• If*Notes*stays*as*Debt*=(Get(back(principal(and(interest(ahead(of(other(equity((behind(other(creditors(typically)(
• If*Notes*Convert**=(Convert(amount(of(debt(and(interest(into(equity(at(the(valuaTon(in(the(next(round(
• ( aier(applicaTon(of(a(Discount((oien(15(–(25%)(• ( subject(to(a(maximum(valuaTon(amount((the(“Cap”)(
*
Basic(Structure(of(ConverTble(Debt(
• Investor(loans($(to(Company(an#cipa#ng(another(round(of(funding(• Investment(accrues(small(interest((6L8%(typical)(• When(the(funding(occurs,(investment(+(interest(convert(to(equity,(
usually(at(a(discount((15L25%(typical)((
Example:(• Investors(loan($200K(to(Company((• 20%(discount(• As(of(conversion,(interest(of($10k(has(accrued(• Next(Round(PM(=($2m;(1M(shares(before(financing(• New(Shares(offered(at($2/each((At(Conversion,(Noteholders(receive(210K(/(1.60(shares(=(131,250(shares(
Converts–(ComplicaTons!(
• What(if(only(a(li3le(money(comes(in?(• When(does(the(debt(convert?(• What(happens(if(PM(of(next(round(is(huge?(• Does(the(investor(have(any(say(in(things?(• What(if(there(is(an(equity(investment(that(doesn’t(trigger(conversion?(
• What(happens(if(it(never(converts?(• What(happens(if(Company(gets(bought?(
Converts–(SoluTons?(
• Caps(and(Floors(• Default(conversion(price(and(security(at(maturity(• Open(round,(minimum(close(• Quick(sale(preferences((ex.(2x)(• Governance(provisions(• Careful(a3enTon(to(conversion(condiTons(
Converts:(Worse(Than(Equity?(
• MulTple(liquidaTon(preference((circa(2008)(– Ex.($500k(of(Notes(with(cap(at($2m(PM(– Next(Round(at($6m(PM(– Issue(Noteholders(3x(number(of(shares(– 3x(shares(equals(3x(liquidaTon(preference!!(
• Without(a(floor,(effecTvely(Full(Ratchet(AnTLdiluTon(• Preference(Overhang(– In(prior(example(Noteholders(bought($262,500(of(preference(for($200,000.(((
– All(other(Series(A(Holders(bought(1:1(preference(• Not(Just(a(Price(Adjustment(
Converts:(When(Do(They(Work?(
• “Bridge”(financing(in(anTcipaTon(of(an(“event”(– Another(financing(– A(big(sale(– Company(sale(
• Seed(stage(investment(– ValuaTon(not(understood(– Rolling(closes((oien(with(ratcheTng(caps)(– Proof(points(as(an(“event”(– When(the(investor(loves(the(company((cf.(exuberant(equity(valuaTons)(
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Convertible Debt December 12, 2013