5 ms·

Is there an entrepreneur willing to say "Yep, tried them, got bitten in the hindquarters", even anonymously? I don't necessarily disbelieve here but it strikes

by patio11 12y ago

Is there an entrepreneur willing to say "Yep, tried them, got bitten in the hindquarters", even anonymously? I don't necessarily disbelieve here but it strikes me that VCs have the curious property of always giving fundraising advice which is in the interest of VCs. I acknowledge that somewhere in this wide world there may actually be a VC motivated primarily by friends-and-family getting appropriate compensation for risky investments but that is not the way I will bet. My understanding -- limited, in that I've been a party to two but from the other side of the table -- is that a major reason they became popular is because they take the fangs out of collusive behavior by investors. The Valley had evolved a "Well, I'll invest if you get a lead" "Well, I'll lead if you close $X" system which froze out a lot of companies if the founders didn't have deep, pre-existing social networks. "You want a lead!" sounds a lot like wistful nostalgia for this gatekeeping behavior. I understand why a gatekeeper would see it that way. I don't understand why the gated would.

joshu 12y ago
It's better for noteholders for the conversion price to be as low as possible. I'm sure this creates bad behavior. I've certainly felt badly about deals that went against me, though I haven't done anything.
csbrooks 12y ago
Congrats on 100,000 karma, btw. O_o
- patio11 12y ago
  Thanks. Man, inside Valley baseball, wouldn't have guessed that would be the cause 6 years ago.
gyardley 12y ago
Not exactly what you're asking for, but I did a priced first round because my investors insisted on it and believe it helped me a great deal more than a convertible note would've. In particular, what Suster says about the importance of having a lead rings absolutely true to me. My investors were a huge help when figuring out a complicated merger that eventually led to a terrific outcome. If I had raised from a big bunch of smaller, not-particularly-invested angels instead - well, who's to say, but I suspect I would've botched it.
msuster 12y ago
This is mark (the author). I totally get why i would be seen as biased. I have given this advice hundreds of times in small sessions verbally and I REALLY have no interest in driving my point of view for me. I do 2 deals a year. It barely matters to me personally. Do me a favor. Ask around to experienced entrepreneurs who have done 3-5 companies and stretching back to at least the mid to late 90s. I promise you you'll hear similar views to mine. Also, ask some very smart lawyers for a balanced view. I think you'll mostly hear the same. re: gate keeper protecting the establishment. I know you don't know me but truthfully it is nothing of the sort. I think in simple life lessons. When you matter more to a small set of people they have more interest in helping you in tough times. If you never make mistakes or struggle then the argument of not having strong leads makes sense. It's just that this is the edge case. Good luck.
- bdcs 12y ago
  Thank you for your reply on HN. Can you also please reply to grellas's post (at or near the top)? grellas is a "very smart lawyer" who posted some excellent counter-points to your original article. Personally, I'd love to hear your response.
  - jacquesm 12y ago
    Seconded.
  - ganeumann 12y ago
    I think grella said the advantages of convertible notes are: 1. First note is capped but later notes can be uncapped; 2. Fewer tax risks; 3. Doesn't mess up your equity pricing; 4. You can do a number of notes with different amounts raised; 5. You don't give your investors the kind of protections they would get in equity rounds. I'd like to hear Mark's reply too. My opinion below. I tend to think that all of these things (aside from the tax risks) are either inconsequential in comparison to equity financing (3, 4), or simply the result of having unsophisticated or uncaring investors (1, 5). The tax risks he did not explain; I assume he means the risk that the IRS would use an equity round to peg a value on shares or options given to employees that differs from what the company assumed. If so, this risk exists no matter what. I agree that giving the investors less protective provisions or uncapped notes is better for the company. If you can get investors to agree to that, good for you, but that's separate from structure. The primary problem with convertible notes as they are used today for entrepreneurs is that the investor gets the lower of the cap or a discount to the next round. This optionality is paid for by the entrepreneur. And while, as grella points out, the cost of this optionality is usually pretty low, so is the value of the benefits he points out.
theflyingkiwi42 12y ago
Not entirely related but to the point of Mark's 'bias'. I had a meeting with him many years ago when he just got started at GRP. Despite his very clear 'No' to our pitch, he gave some of the best, and direct, advice I received and nearly 5 years later it is still serving me well. It allowed me to do what I wanted without needing to raise money at that point. Of course that makes me biased towards his post so take my opinion with a grain of salt :) That said, Mark seems one of the guys that really likes to help entrepreneurs. I read his post not as "Don't ever do a note" but "be very aware of unintended consequences". As I am starting to fundraise for a new company, I've felt incredibly uncomfortable with convertible notes for the reasons Mark outlined in his post. I thought I was being paranoid since everybody is saying notes are the way to go, so it is nice to read an opposing view.
pbiggar 12y ago
> Is there an entrepreneur willing to say "Yep, tried them, got bitten in the hindquarters", Kinda, but in a different way. When we were raising our Series A round, some investors based their offer off our Seed round's valuation. One investor thought that our seed round was a capped note, and wrote us a term sheet that was a "generous increase over your cap" (I think 20% perhaps). I think if they had known the seed was a priced round, they would have made something more like a 100% increase over it's valuation.
- deleted 12y ago
  [deleted]
throwawayabc999 12y ago
YC founder here. One major problem with convertible debt in that it is fundamentally debt with an X year term and Y% interest rate. If the startup chooses not to raise further capital, the note does not dictate what is done (at least ours didn't). This isn't much of a problem if your investors are really nice, smart people. But if they aren't... I've had the experience of a non-entrepreneur-friendly investor calling the debt (e.g. demanding repayment after the term had expired) at a time when our startup couldn't make a payment of that size. They refused to extend the term. The investor then threatened to liquidate the company if we didn't pay them back. Some of my cofounders had made money in the past, so we repaid the debt by having them lend money to the company. But I'm not sure what we would have done if we didn't have that option.

by patio11 12y ago

joshu 12y ago

It's better for noteholders for the conversion price to be as low as possible. I'm sure this creates bad behavior. I've certainly felt badly about deals that went against me, though I haven't done anything.

csbrooks 12y ago

Congrats on 100,000 karma, btw. O_o

patio11 12y ago
Thanks. Man, inside Valley baseball, wouldn't have guessed that would be the cause 6 years ago.

gyardley 12y ago

Not exactly what you're asking for, but I did a priced first round because my investors insisted on it and believe it helped me a great deal more than a convertible note would've. In particular, what Suster says about the importance of having a lead rings absolutely true to me. My investors were a huge help when figuring out a complicated merger that eventually led to a terrific outcome. If I had raised from a big bunch of smaller, not-particularly-invested angels instead - well, who's to say, but I suspect I would've botched it.

msuster 12y ago

This is mark (the author). I totally get why i would be seen as biased. I have given this advice hundreds of times in small sessions verbally and I REALLY have no interest in driving my point of view for me. I do 2 deals a year. It barely matters to me personally. Do me a favor. Ask around to experienced entrepreneurs who have done 3-5 companies and stretching back to at least the mid to late 90s. I promise you you'll hear similar views to mine. Also, ask some very smart lawyers for a balanced view. I think you'll mostly hear the same. re: gate keeper protecting the establishment. I know you don't know me but truthfully it is nothing of the sort. I think in simple life lessons. When you matter more to a small set of people they have more interest in helping you in tough times. If you never make mistakes or struggle then the argument of not having strong leads makes sense. It's just that this is the edge case. Good luck.

bdcs 12y ago
Thank you for your reply on HN. Can you also please reply to grellas's post (at or near the top)? grellas is a "very smart lawyer" who posted some excellent counter-points to your original article. Personally, I'd love to hear your response.
- jacquesm 12y ago
  Seconded.
- ganeumann 12y ago
  I think grella said the advantages of convertible notes are: 1. First note is capped but later notes can be uncapped; 2. Fewer tax risks; 3. Doesn't mess up your equity pricing; 4. You can do a number of notes with different amounts raised; 5. You don't give your investors the kind of protections they would get in equity rounds. I'd like to hear Mark's reply too. My opinion below. I tend to think that all of these things (aside from the tax risks) are either inconsequential in comparison to equity financing (3, 4), or simply the result of having unsophisticated or uncaring investors (1, 5). The tax risks he did not explain; I assume he means the risk that the IRS would use an equity round to peg a value on shares or options given to employees that differs from what the company assumed. If so, this risk exists no matter what. I agree that giving the investors less protective provisions or uncapped notes is better for the company. If you can get investors to agree to that, good for you, but that's separate from structure. The primary problem with convertible notes as they are used today for entrepreneurs is that the investor gets the lower of the cap or a discount to the next round. This optionality is paid for by the entrepreneur. And while, as grella points out, the cost of this optionality is usually pretty low, so is the value of the benefits he points out.

theflyingkiwi42 12y ago

Not entirely related but to the point of Mark's 'bias'. I had a meeting with him many years ago when he just got started at GRP. Despite his very clear 'No' to our pitch, he gave some of the best, and direct, advice I received and nearly 5 years later it is still serving me well. It allowed me to do what I wanted without needing to raise money at that point. Of course that makes me biased towards his post so take my opinion with a grain of salt :) That said, Mark seems one of the guys that really likes to help entrepreneurs. I read his post not as "Don't ever do a note" but "be very aware of unintended consequences". As I am starting to fundraise for a new company, I've felt incredibly uncomfortable with convertible notes for the reasons Mark outlined in his post. I thought I was being paranoid since everybody is saying notes are the way to go, so it is nice to read an opposing view.

pbiggar 12y ago

> Is there an entrepreneur willing to say "Yep, tried them, got bitten in the hindquarters", Kinda, but in a different way. When we were raising our Series A round, some investors based their offer off our Seed round's valuation. One investor thought that our seed round was a capped note, and wrote us a term sheet that was a "generous increase over your cap" (I think 20% perhaps). I think if they had known the seed was a priced round, they would have made something more like a 100% increase over it's valuation.

deleted 12y ago
[deleted]

throwawayabc999 12y ago

YC founder here. One major problem with convertible debt in that it is fundamentally debt with an X year term and Y% interest rate. If the startup chooses not to raise further capital, the note does not dictate what is done (at least ours didn't). This isn't much of a problem if your investors are really nice, smart people. But if they aren't... I've had the experience of a non-entrepreneur-friendly investor calling the debt (e.g. demanding repayment after the term had expired) at a time when our startup couldn't make a payment of that size. They refused to extend the term. The investor then threatened to liquidate the company if we didn't pay them back. Some of my cofounders had made money in the past, so we repaid the debt by having them lend money to the company. But I'm not sure what we would have done if we didn't have that option.