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Doing a seed round now. Ultimately the terms are going to depend on investor consensus, but my strong preference is to go uncapped w/ discount. Having a cap i

Doing a seed round now. Ultimately the terms are going to depend on investor consensus, but my strong preference is to go uncapped w/ discount. Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". For some seed investors an early valuation & equity conversion may be desirable, but I'd rather "grow until I'm 6 months away from needing funds to (grow faster|survive)". Having no cap, on the other hand, encourages me to stay lean, grow quickly & ask for money only when it has the greatest value. That's behaviour which may not be friendly to opportunistic short-term VCs looking to get a quick valuation bump, but which is strongly correlated with long-term success and eventual home-runs. I want to give a discount because seed investors are taking a big risk on me, they deserve it.

anotherfounder 9y ago
This makes a lot of sense, and is also my preferred route. Have you had any feedback or pushback on this route yet? I am also curious how the reactions differ from Angels to MicroVCs to Seed Funds.
- DelaneyM 9y ago
  So far everyone's been happy with an MFN, so it hasn't been much of an issue. (They seem happy to let someone else be "the bad guy" who forces terms.) If I secure enough commitment on MFN agreements alone, I plan to default them all into a fairly generous discount.
CalChris 9y ago
> Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". This was my impression as well. I do understand that the deal has to be equitable for both sides. It also has to align interests and as your example shows, the cap doesn't. The discount obviously makes sense since the seed funder is taking more risk.
lpolovets 9y ago
(I'm a VC) Uncapped notes are generally a bad idea for everyone involved because they misalign incentives. If you raise a seed at a $6m cap, both your goal and your investors' goal is to help you make as much progress as possible for a Series A. For instance, investors will do whatever they can to help you get to a $30m valuation instead of a $20m valuation. An uncapped note means that investors invest at your next round's price. That means they benefit most of the price of your next round is low. I.e. they'll do as little as possible so that your Series A is at a $20m pre instead of a $30m pre. The misalignment creates perverse incentives. For example, if you ask an investor on an uncapped note to make a key customer intro, if they say yes then their reward if you land the customer is that they'll have even less ownership at the Series A. That's not a good incentive structure :)
- DelaneyM 9y ago
  Does your assessment change at all if your horizon extends beyond the next round?
  - lpolovets 9y ago
    Not really. If a fair price for your company is $10m today or $40m in a year if you do well, there isn't a good reason to invest at $40m today (or even a discount like 20% off $40m). An analogy: Amazon is $1k/share today. Let's say you think there's a 30% chance it will 3x in the next year. Would you like to invest at $2.5k/share today? The answer is No because that has negative expected value, and you'd rather just wait a year and invest at $3k/share than investing at a small discount to $3k/share today when the stock is worth much less than that. Also, the time horizon doesn't change the misaligned incentives here. Because I get in at next round's price, I would prefer for that price to be lower.
    - pcmaffey 9y ago
      Isn't the whole point of notes to address the uncertainty of valuation? In your example, what happens when there's no 'fair price today'? If you think there's a 30% chance Amazon will be worth 3k in a year, what price would you pay now?
ares2012 9y ago
No investor will do an uncapped note (unless it's a bridge round) because it's a very bad deal for them. A fixed discount on the round is not enough upside to account for their risk, especially when there are plenty of investments available whether they can get a cap which gives them much more upside. Investors will do uncapped notes for bridges because there is usually a very short time period between the note and the next round, so they actually make a better return due to the discount than they would in equity appreciation over that short time.

anotherfounder 9y ago

This makes a lot of sense, and is also my preferred route. Have you had any feedback or pushback on this route yet? I am also curious how the reactions differ from Angels to MicroVCs to Seed Funds.

DelaneyM 9y ago
So far everyone's been happy with an MFN, so it hasn't been much of an issue. (They seem happy to let someone else be "the bad guy" who forces terms.) If I secure enough commitment on MFN agreements alone, I plan to default them all into a fairly generous discount.

CalChris 9y ago

> Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". This was my impression as well. I do understand that the deal has to be equitable for both sides. It also has to align interests and as your example shows, the cap doesn't. The discount obviously makes sense since the seed funder is taking more risk.

lpolovets 9y ago

(I'm a VC) Uncapped notes are generally a bad idea for everyone involved because they misalign incentives. If you raise a seed at a $6m cap, both your goal and your investors' goal is to help you make as much progress as possible for a Series A. For instance, investors will do whatever they can to help you get to a $30m valuation instead of a $20m valuation. An uncapped note means that investors invest at your next round's price. That means they benefit most of the price of your next round is low. I.e. they'll do as little as possible so that your Series A is at a $20m pre instead of a $30m pre. The misalignment creates perverse incentives. For example, if you ask an investor on an uncapped note to make a key customer intro, if they say yes then their reward if you land the customer is that they'll have even less ownership at the Series A. That's not a good incentive structure :)

DelaneyM 9y ago
Does your assessment change at all if your horizon extends beyond the next round?
- lpolovets 9y ago
  Not really. If a fair price for your company is $10m today or $40m in a year if you do well, there isn't a good reason to invest at $40m today (or even a discount like 20% off $40m). An analogy: Amazon is $1k/share today. Let's say you think there's a 30% chance it will 3x in the next year. Would you like to invest at $2.5k/share today? The answer is No because that has negative expected value, and you'd rather just wait a year and invest at $3k/share than investing at a small discount to $3k/share today when the stock is worth much less than that. Also, the time horizon doesn't change the misaligned incentives here. Because I get in at next round's price, I would prefer for that price to be lower.
  - pcmaffey 9y ago
    Isn't the whole point of notes to address the uncertainty of valuation? In your example, what happens when there's no 'fair price today'? If you think there's a 30% chance Amazon will be worth 3k in a year, what price would you pay now?

ares2012 9y ago

No investor will do an uncapped note (unless it's a bridge round) because it's a very bad deal for them. A fixed discount on the round is not enough upside to account for their risk, especially when there are plenty of investments available whether they can get a cap which gives them much more upside. Investors will do uncapped notes for bridges because there is usually a very short time period between the note and the next round, so they actually make a better return due to the discount than they would in equity appreciation over that short time.