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Can anyone explain the terms "no cap" and "no discount" in "$150,000 in convertible debt. With no cap and no discount."? I understand what a debt is, so how is

Can anyone explain the terms "no cap" and "no discount" in "$150,000 in convertible debt. With no cap and no discount."? I understand what a debt is, so how is "no cap and no discount debt" different from a regular debt? Also why would you as a startup would want to take a debt? Another question - what's the point of Yuri giving the debt, it seems he's not even asking for equity in return?

ebaysucks 16y ago
When offering convertible debt, the investor accepts the valuation at the next round of investments (in this case series A). The risk for the convertible debt investor is that this valuation will be very high and the series A can take a long time. To limit this risk convertible debt investors negotiate valuation caps and discounts. Cap: The convertible debt gets converted at min=[series A valuation, cap]. Discount: The convertible debt gets converted at series A valuation * (1- discount) (Obviously, when both cap and discount apply, the valuation for conversion becomes min = [series A valuation * (1 - discount), cap].)
- aneesh 16y ago
  I think you mean min(series A valuation, cap).
  - ebaysucks 16y ago
    This is correct. Made the edit. I hope I didn't confuse anyone with my original post.
- cft 16y ago
  Can somebody give me an advice. We have a two person startup, that is making about 20k/mo and it's growing. I am the founder. The thing is, I do not currently plan to raise VC money. My goal is to achieve revenue of 200k/mo by 2013. It is very realistic, but the problem is that as the service grows, we spend more and more time on operations, since certain things were not timely automated. We need about 300k , so that we can hire a couple of contractors to automate operations, to accelerate product development. But since I do not plan to raise a VC round, the convertible loan would not work. What is the right mechanism for this investment? I also believe the risk is lower than normal, since we have been making money for a while, and this should be reflected in the terms and in the valuation. Is this the domain of angels to make such an investment?
  - 2arrs2ells 16y ago
    I think what you're looking for is a loan. Not sure if it's possible to get $300k on $20k/month revenue, though.
    - hugh3 16y ago
      Not unless you're willing to put up (say) your house against it. If I were a bank I wouldn't be willing to take the risk that your business will go under before it ever pays back the $300K. Basically you need a small-scale VC or large-scale angel investment... or else to continue to bootstrap.
    - cft 16y ago
      FYI: Last time I stopped at the bank where I opened business checking account 2+ years ago (Wells Fargo), they sat me down and offered a 100K line of credit (the interest rate was unknown unless I applied, but she said it would be around 7-8%). The service is poorly monetized ( disproportionately high hosting fees + new hardware expenses / revenue). Until recently I was putting all these hosting related expenses on a single US Bank credit card (and paying it off monthly). In response, they raised the credit line to 40k at 8% yearly interest. This is less however than the 300k, that I think is needed. Additionally, I would prefer to use this kind bank debt financing only in an emergency, because I suppose that unlike a savvy investor, Wells Fargo and US Bank would be absolutely inflexible if I say need slightly more time, and would drive the company into default by their blanket policy, regardless of the specific circumstances.
  - ebaysucks 16y ago
    You can still accept a convertible debt investment. If you don't do a series A the valuation of the sale of the company will be taken. A sale without investments in between would mean a debt investor only gets his money back + interest. Given your situation, the debt investor might negotiate a time limit for the conversion (and either a cap or a formula for the valuation at that point).
  - dacort 16y ago
    You may want to look into royalty/revenue based financing. I don't know if your revenue is where it needs to be for that (i.e. revenueloan.com's typical investment makes $1-5MM in revenue), but something to look in to.
ladon86 16y ago
Quick answer - he does get equity at the next funding round. What he gets is the amount of equity that $150,000 would buy at that valuation. So if someone else invests $250,000 for 25%, that's a valuation of $1m. Yuri would get 15% at that valuation. He'd get 7.5% at a $2m valuation and so forth.
- pkrumins 16y ago
  What happens if there is no next funding round (startup fails)? Do the startup founders have to return the debt?
  - ladon86 16y ago
    Generally not, and I'm quite sure they wouldn't have to for this deal. Obviously any exit event would be a valuation and Yuri would get a cut. But in case of failure, everyone walks away empty-handed.
  - sdrinf 16y ago
    "Startup fails" is the reason why these companies have the so-called "limited liability". They file for bankruptcy, founders get on with their lifes, investors see nothing. This is, in fact the vast majority of the cases, and the reason investing is called "high-risk, high reward".
  - jaredstenquist 16y ago
    All is a loss. Entrepreneurs are not help personally liable for the debt in this case.
- rudiger 16y ago
  What happens if there is no exit or "liquidity event", but the startup is profitable and never takes additional funding? When does the $150K become equity?
  - aneth 16y ago
    Some notes have automatic conversion at a given valuation (usually the 'floor', which in this case does not exist.) Others have no such clause, presumably under the incorrect assumption that a "liquidity event" will always happen if there is a success. I've dealt with both types of notes before and always insisted on adding an automatic conversion clause.
yokumtaku 16y ago
See http://www.startupcompanylawyer.com/2007/04/28/what-should-the-conversion-discount-be-for-a-bridge-note-into-preferred-stock/ http://www.startupcompanylawyer.com/2007/04/28/what-should-t... and http://www.startupcompanylawyer.com/2010/01/11/what-is-a-convertible-bridge-note-with-a-price-cap/ http://www.startupcompanylawyer.com/2010/01/11/what-is-a-con...

ebaysucks 16y ago

When offering convertible debt, the investor accepts the valuation at the next round of investments (in this case series A). The risk for the convertible debt investor is that this valuation will be very high and the series A can take a long time. To limit this risk convertible debt investors negotiate valuation caps and discounts. Cap: The convertible debt gets converted at min=[series A valuation, cap]. Discount: The convertible debt gets converted at series A valuation * (1- discount) (Obviously, when both cap and discount apply, the valuation for conversion becomes min = [series A valuation * (1 - discount), cap].)

aneesh 16y ago
I think you mean min(series A valuation, cap).
- ebaysucks 16y ago
  This is correct. Made the edit. I hope I didn't confuse anyone with my original post.
cft 16y ago
Can somebody give me an advice. We have a two person startup, that is making about 20k/mo and it's growing. I am the founder. The thing is, I do not currently plan to raise VC money. My goal is to achieve revenue of 200k/mo by 2013. It is very realistic, but the problem is that as the service grows, we spend more and more time on operations, since certain things were not timely automated. We need about 300k , so that we can hire a couple of contractors to automate operations, to accelerate product development. But since I do not plan to raise a VC round, the convertible loan would not work. What is the right mechanism for this investment? I also believe the risk is lower than normal, since we have been making money for a while, and this should be reflected in the terms and in the valuation. Is this the domain of angels to make such an investment?
- 2arrs2ells 16y ago
  I think what you're looking for is a loan. Not sure if it's possible to get $300k on $20k/month revenue, though.
  - hugh3 16y ago
    Not unless you're willing to put up (say) your house against it. If I were a bank I wouldn't be willing to take the risk that your business will go under before it ever pays back the $300K. Basically you need a small-scale VC or large-scale angel investment... or else to continue to bootstrap.
  - cft 16y ago
    FYI: Last time I stopped at the bank where I opened business checking account 2+ years ago (Wells Fargo), they sat me down and offered a 100K line of credit (the interest rate was unknown unless I applied, but she said it would be around 7-8%). The service is poorly monetized ( disproportionately high hosting fees + new hardware expenses / revenue). Until recently I was putting all these hosting related expenses on a single US Bank credit card (and paying it off monthly). In response, they raised the credit line to 40k at 8% yearly interest. This is less however than the 300k, that I think is needed. Additionally, I would prefer to use this kind bank debt financing only in an emergency, because I suppose that unlike a savvy investor, Wells Fargo and US Bank would be absolutely inflexible if I say need slightly more time, and would drive the company into default by their blanket policy, regardless of the specific circumstances.
- ebaysucks 16y ago
  You can still accept a convertible debt investment. If you don't do a series A the valuation of the sale of the company will be taken. A sale without investments in between would mean a debt investor only gets his money back + interest. Given your situation, the debt investor might negotiate a time limit for the conversion (and either a cap or a formula for the valuation at that point).
- dacort 16y ago
  You may want to look into royalty/revenue based financing. I don't know if your revenue is where it needs to be for that (i.e. revenueloan.com's typical investment makes $1-5MM in revenue), but something to look in to.

ladon86 16y ago

Quick answer - he does get equity at the next funding round. What he gets is the amount of equity that $150,000 would buy at that valuation. So if someone else invests $250,000 for 25%, that's a valuation of $1m. Yuri would get 15% at that valuation. He'd get 7.5% at a $2m valuation and so forth.

pkrumins 16y ago
What happens if there is no next funding round (startup fails)? Do the startup founders have to return the debt?
- ladon86 16y ago
  Generally not, and I'm quite sure they wouldn't have to for this deal. Obviously any exit event would be a valuation and Yuri would get a cut. But in case of failure, everyone walks away empty-handed.
- sdrinf 16y ago
  "Startup fails" is the reason why these companies have the so-called "limited liability". They file for bankruptcy, founders get on with their lifes, investors see nothing. This is, in fact the vast majority of the cases, and the reason investing is called "high-risk, high reward".
- jaredstenquist 16y ago
  All is a loss. Entrepreneurs are not help personally liable for the debt in this case.
rudiger 16y ago
What happens if there is no exit or "liquidity event", but the startup is profitable and never takes additional funding? When does the $150K become equity?
- aneth 16y ago
  Some notes have automatic conversion at a given valuation (usually the 'floor', which in this case does not exist.) Others have no such clause, presumably under the incorrect assumption that a "liquidity event" will always happen if there is a success. I've dealt with both types of notes before and always insisted on adding an automatic conversion clause.

yokumtaku 16y ago

See http://www.startupcompanylawyer.com/2007/04/28/what-should-the-conversion-discount-be-for-a-bridge-note-into-preferred-stock/ http://www.startupcompanylawyer.com/2007/04/28/what-should-t... and http://www.startupcompanylawyer.com/2010/01/11/what-is-a-convertible-bridge-note-with-a-price-cap/ http://www.startupcompanylawyer.com/2010/01/11/what-is-a-con...