4 ms·

So this investment isn't at a valuation and the valuation is only decided at a future round at which point this converts into an amount of equity based off that

by robryan 16y ago

So this investment isn't at a valuation and the valuation is only decided at a future round at which point this converts into an amount of equity based off that valuation? I've read about convertible notes before just a little confusing at first.

staunch 16y ago
Right. $150,000 paid in advance. Whenever the company raises its first significant money (usually >=$1M) that $150,000 buys equity at the same rate the new investors are paying.
- hugh3 16y ago
  Is there any way to game this? For instance: 1. I get $150K in convertible debt from Yuri. 2. At the end of YC, my rich friend Joe decides to invest a million dollars in my company at a valuation of five hundred trillion dollars. Yuri thus gets an insanely small slice of my company. 3. Two days later, my company buys Joe's shares back for a million dolars. 4. Now my company goes off to seek actual funding at a sane valuation. Yuri gets annoyed.
  - jmtame 16y ago
    it's not worth ruining your reputation over screwing a single investor especially in a deal this small. it's a small community and even if you found a way to trick the investor in this situation, it reflects very poorly on you. i'm sure there are ways to game it, but why even bother? yc is a small network; if one founder screws someone else, everyone knows about it. vice versa.
  - peteforde 16y ago
    You're leaving out the part about getting accepted into YC and then being willing to blackball your reputation and ability to ever raise money to do anything, again. Who would do that for $150k? To me, this is the equivalent of leaving $20 on the table to see if you can trust your friends.
    - jacquesm 16y ago
      I'm fairly sure that they can afford lawyers good enough to close that particular loophole.
    - hugh3 16y ago
      Fair enough. I was just wondering whether there were any legal barriers built in to stop people doing these sorts of dodgy deals.
      - peteforde 16y ago
        The SEC or IRS would probably consider this some variation of conspiracy to commit fraud. I'm not an American, so I am guessing.
        brc 16y ago
        Pretty sure the SEC is nowhere near these deals as all are private, probably under some type of 'sophisticated investor' rule anyway. IRS couldn't care who ripped off whom as long as they get their pound of flesh.
  - dennisgorelik 16y ago
    If that happens, Yuri would be insanely profitable. Five hundred trillion dollars are coming into the company. Then all that shares are bought back. So now Yuri has substantial share of these five hundred trillion dollars. Even if Yuri's share would be just 1% -- 5 trillion dollars would allow Yuri never work again.
  - hristov 16y ago
    You probably will not be able to pull off part 3. There are duties the company has towards its shareholders. Thus, it will often cause legal problems for the company to buy out one person's stock without offering to buy everyone's stock for the same price. That's why when companies buy back stock they tend to use tender offers that are extended towards all shareholders. This is not legal advice. The legal issues here are more complex than this post calls for.
webwright 16y ago
In the event of a funding event (or change of control), this $150k turns into $150k worth of stock at the valuation established AT THAT TIME. Example #1: Company A takes the offer and sells for $1m in 6 months. The debt converts to $150k in stock, netting the investor $150k. Example #2: Company B takes the the offer and raises $1m at a pre-money valuation of $3m (selling 25% of the company and establishing a post-money valuation of $4m). The $150k turns into $150k in stock at the new valuation, so 3.75% of the company. Normally, there are various ways (discounts, caps, etc) to reward the early investor for the additional risk they are taking for investing so early. Basically what this means is YC companies can (if they want) eschew funding at demo day, hold out for great terms, or just get busy creating value and raise money when they have more leverage. This is huge.
- rudiger 16y ago
  After reading this explanation, it's hard not to acknowledge this as a disruptive gamechanger. I mean, this completely changes the game for YC and every one of their successful applicants.

by robryan 16y ago

staunch 16y ago

Right. $150,000 paid in advance. Whenever the company raises its first significant money (usually >=$1M) that $150,000 buys equity at the same rate the new investors are paying.

hugh3 16y ago
Is there any way to game this? For instance: 1. I get $150K in convertible debt from Yuri. 2. At the end of YC, my rich friend Joe decides to invest a million dollars in my company at a valuation of five hundred trillion dollars. Yuri thus gets an insanely small slice of my company. 3. Two days later, my company buys Joe's shares back for a million dolars. 4. Now my company goes off to seek actual funding at a sane valuation. Yuri gets annoyed.
- jmtame 16y ago
  it's not worth ruining your reputation over screwing a single investor especially in a deal this small. it's a small community and even if you found a way to trick the investor in this situation, it reflects very poorly on you. i'm sure there are ways to game it, but why even bother? yc is a small network; if one founder screws someone else, everyone knows about it. vice versa.
- peteforde 16y ago
  You're leaving out the part about getting accepted into YC and then being willing to blackball your reputation and ability to ever raise money to do anything, again. Who would do that for $150k? To me, this is the equivalent of leaving $20 on the table to see if you can trust your friends.
  - jacquesm 16y ago
    I'm fairly sure that they can afford lawyers good enough to close that particular loophole.
  - hugh3 16y ago
    Fair enough. I was just wondering whether there were any legal barriers built in to stop people doing these sorts of dodgy deals.
    - peteforde 16y ago
      The SEC or IRS would probably consider this some variation of conspiracy to commit fraud. I'm not an American, so I am guessing.
      - brc 16y ago
        Pretty sure the SEC is nowhere near these deals as all are private, probably under some type of 'sophisticated investor' rule anyway. IRS couldn't care who ripped off whom as long as they get their pound of flesh.
- dennisgorelik 16y ago
  If that happens, Yuri would be insanely profitable. Five hundred trillion dollars are coming into the company. Then all that shares are bought back. So now Yuri has substantial share of these five hundred trillion dollars. Even if Yuri's share would be just 1% -- 5 trillion dollars would allow Yuri never work again.
- hristov 16y ago
  You probably will not be able to pull off part 3. There are duties the company has towards its shareholders. Thus, it will often cause legal problems for the company to buy out one person's stock without offering to buy everyone's stock for the same price. That's why when companies buy back stock they tend to use tender offers that are extended towards all shareholders. This is not legal advice. The legal issues here are more complex than this post calls for.

webwright 16y ago

In the event of a funding event (or change of control), this $150k turns into $150k worth of stock at the valuation established AT THAT TIME. Example #1: Company A takes the offer and sells for $1m in 6 months. The debt converts to $150k in stock, netting the investor $150k. Example #2: Company B takes the the offer and raises $1m at a pre-money valuation of $3m (selling 25% of the company and establishing a post-money valuation of $4m). The $150k turns into $150k in stock at the new valuation, so 3.75% of the company. Normally, there are various ways (discounts, caps, etc) to reward the early investor for the additional risk they are taking for investing so early. Basically what this means is YC companies can (if they want) eschew funding at demo day, hold out for great terms, or just get busy creating value and raise money when they have more leverage. This is huge.

rudiger 16y ago
After reading this explanation, it's hard not to acknowledge this as a disruptive gamechanger. I mean, this completely changes the game for YC and every one of their successful applicants.