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So question: in a rolling close with convertible notes, what happens if the startup neither gets a buy out offer nor raises another round of capital?

by ankeshk 16y ago

pg 16y ago
In any startup, if there's never an exit, the investors lose their money.
- ankeshk 16y ago
  Thanks. It could also happen that the startup doesn't require more capital and is self sustaining. But doesn't get a buy out offer until after the convertible notes expire. In which case, the investor doesn't get to enjoy in the returns - he just gets his money back with some interest. YC companies get a lot of publicity. And so their chances of raising another round of capital or getting bought out are very good. This is not the case with most startups. So a rolling close with convertible notes may not be the best option from investor point of view - no? (With an equity deal, the startup can get an exit until it goes out of business. With a convertible notes deal, you have a fixed timeframe and you (as an early stage investor) lose out if the exit happens beyond that time period... ...So I thought one never did a convertible notes deal unless they knew there was a very very good chance of an exit within the specified time frame... am I missing something? My point is - I don't see rolling closes with convertible notes getting too popular with most angels.)
  - oomieboomie 16y ago
    The convertible note doesn't disappear. In the worst case it merely converts to stock at a pre-configured valuation.
- DanielRibeiro 16y ago
  If the startup starts making lots of revenue (just for argument's sake, I am not actually implying this happens with any noticeable frequency), wouldn't the investors get part of it, even without an exit?
  - joelhaus 16y ago
    A business certainly can raise private capital, become profitable and remain privately owned. It would be like investing in a public stock because you expect their dividend to grow. I think there is an assumption the VC agreement is structured without any sharing of operating profits, but I'm not sure why it has to be this way... anyone care to enlighten? If a profit sharing component was added to this model, you could significantly reduce investor risk, possibly offer better terms to founders and create an added incentive for finding businesses that have a monetizable product or service. Maybe YC is trying to avoid founders that bow to these constraints in favor of startups focusing purely on the product? There is nothing wrong with this, but it might just be delaying the inevitable; someone, somewhere will need to make a profit from it or the business will surely die.
gojomo 16y ago
I believe convertible notes still have some far-off due date, and they are accruing some nominal interest rate. So at some point, the money comes due if never converted (and the company is still in business). If the company reaches a point where it will need no outside capital (nor pursue acquisition/IPO), it could have a 'round' that simply converts the debt to equity at some agreed-upon value. Then, perhaps, the original investors can at least start the capital-gains clock, collect dividends, sell shares on a private market, etc.

So question: in a rolling close with convertible notes, what happens if the startup neither gets a buy out offer nor raises another round of capital?

by ankeshk 16y ago

So question: in a rolling close with convertible notes, what happens if the startup neither gets a buy out offer nor raises another round of capital?

pg 16y ago

In any startup, if there's never an exit, the investors lose their money.

ankeshk 16y ago
Thanks. It could also happen that the startup doesn't require more capital and is self sustaining. But doesn't get a buy out offer until after the convertible notes expire. In which case, the investor doesn't get to enjoy in the returns - he just gets his money back with some interest. YC companies get a lot of publicity. And so their chances of raising another round of capital or getting bought out are very good. This is not the case with most startups. So a rolling close with convertible notes may not be the best option from investor point of view - no? (With an equity deal, the startup can get an exit until it goes out of business. With a convertible notes deal, you have a fixed timeframe and you (as an early stage investor) lose out if the exit happens beyond that time period... ...So I thought one never did a convertible notes deal unless they knew there was a very very good chance of an exit within the specified time frame... am I missing something? My point is - I don't see rolling closes with convertible notes getting too popular with most angels.)
- oomieboomie 16y ago
  The convertible note doesn't disappear. In the worst case it merely converts to stock at a pre-configured valuation.
DanielRibeiro 16y ago
If the startup starts making lots of revenue (just for argument's sake, I am not actually implying this happens with any noticeable frequency), wouldn't the investors get part of it, even without an exit?
- joelhaus 16y ago
  A business certainly can raise private capital, become profitable and remain privately owned. It would be like investing in a public stock because you expect their dividend to grow. I think there is an assumption the VC agreement is structured without any sharing of operating profits, but I'm not sure why it has to be this way... anyone care to enlighten? If a profit sharing component was added to this model, you could significantly reduce investor risk, possibly offer better terms to founders and create an added incentive for finding businesses that have a monetizable product or service. Maybe YC is trying to avoid founders that bow to these constraints in favor of startups focusing purely on the product? There is nothing wrong with this, but it might just be delaying the inevitable; someone, somewhere will need to make a profit from it or the business will surely die.

gojomo 16y ago

I believe convertible notes still have some far-off due date, and they are accruing some nominal interest rate. So at some point, the money comes due if never converted (and the company is still in business). If the company reaches a point where it will need no outside capital (nor pursue acquisition/IPO), it could have a 'round' that simply converts the debt to equity at some agreed-upon value. Then, perhaps, the original investors can at least start the capital-gains clock, collect dividends, sell shares on a private market, etc.