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I'm not a lawyer, and at the risk of sounding stupid, there's something I don't get. Every time someone talks about debt v. equity in funding a startup they sa

I'm not a lawyer, and at the risk of sounding stupid, there's something I don't get. Every time someone talks about debt v. equity in funding a startup they say that debt is better because it is less paperwork, easier and cheaper. For instance, Carolynn says: "Financing documents, no matter how streamlined, have a lot of provisions that are complicated and require a not-insignificant amount of time and attention to slog through. Should the investor have a board seat? What protective provisions are appropriate versus onerous? What voting threshold should trigger this drag-along provision? What exactly is a registration right? Startup founders are typically not savvy about financing terms and are thus required to get up to speed at a particularly inconvenient time in the company's lifespan. The purpose of these small checks from seed investors is just to get the company off the ground - do people really want to worry about what a "deemed issuance of Additional Shares of Common Stock" is at this point in time?" So equity docs are more expensive than debt because they're more complicated. And they're more complicated because they have all these provisions and protections that debt docs don't. But if you created equity docs that didn't have all these provisions, wouldn't they be pretty much as simple as debt docs? A typical equity deal has these docs: 1. A stock purchase agreement--17 pages, 13 of which are reps and warranties, and closing conditions, things that debt docs usually don't have; 2. A Voting agreement, protections that debt docs don't have; 3. An Investors Rights Agreement, protections that debt docs don't have; 4. A Restated Certificate of Incorporation, protections that debt docs don't have along with changes that debt docs also need to make (increase authorized shares). So if you took out all the stuff that debt docs don't give investors anyway, you have a 4 page stock purchase agreement. Compared to a 8 page convertible note. (I didn't count signature pages in either doc.) This is an honest question, I assume there is a reason, I just don't know what it is.

berberous 12y ago
There are documents out there that keep the "convertible" concept (i.e. figure out the hard stuff later), but do away with the debt aspect: http://techcrunch.com/2012/08/31/thefunded-founder-institute-and-wilson-sonsini-debut-startup-friendly-seed-financing-vehicle-convertible-equity/ http://techcrunch.com/2012/08/31/thefunded-founder-institute...
jalonso510 12y ago
This is the approach you see with the documents at www.seriesseed.com. They strip out a lot of the fluff and combine the remaining items down into just two documents. They're pretty good and can accomplish what you're asking about if both sides are in agreement that the deal is supposed to be simple, but they can be just as complicated as any equity deal if investor's counsel tries to write in more extensive terms that they're used to seeing in equity docs.
bradleyjg 12y ago
In either the debt or equity case if you simply remove terms they will generally be filled in by defaults based on statute, regulations, and case law. If the issues around equity are inherently more complicated than debt, just settling for defaults doesn't much help. Both sides of the transaction are still going to need to familiarize themselves with those issues. An analogy: most people take the default divorce law instead of writing a prenup, but those default rules are complicated, in many cases more complicated than what the parties would draft. So going with the default can save you time upfront (and awkward conversations) but it isn't generallly a good idea, especially if you opt not to understand what you are agreeing to.
- dragonwriter 12y ago
  > An analogy: most people take the default divorce law instead of writing a prenup, but those default rules are complicated, in many cases more complicated than what the parties would draft. Of course, prenuptial agreements may be less complex than "default divorce law", but they don't actually reduce the potential complexity of a divorce, because then the complexity becomes the complexity of the prenuptial agreement, compounded by the complexity of the rules governing the validity of prenuptial agreements (outside of restrictions on particular terms), compounded by the complexity of the rules governing the permitted terms in prenuptial agreements and the conditions in which particular terms are enforceable, compounded by the complexity of the default divorce rules (which cover both the areas that cannot be modified by a prenuptial agreement, and any areas left uncovered if the prenuptial agreement, or particular terms, fail.) So the prenup increases both the up-front and tail-end complexity.
zabramow 12y ago
Really interesting question, I'm sure Clev would have a better answer. My guess is that you're going to have a hard time practically speaking getting an investor to sign an equity document without any of the usual terms in those documents.

berberous 12y ago

There are documents out there that keep the "convertible" concept (i.e. figure out the hard stuff later), but do away with the debt aspect: http://techcrunch.com/2012/08/31/thefunded-founder-institute-and-wilson-sonsini-debut-startup-friendly-seed-financing-vehicle-convertible-equity/ http://techcrunch.com/2012/08/31/thefunded-founder-institute...

jalonso510 12y ago

This is the approach you see with the documents at www.seriesseed.com. They strip out a lot of the fluff and combine the remaining items down into just two documents. They're pretty good and can accomplish what you're asking about if both sides are in agreement that the deal is supposed to be simple, but they can be just as complicated as any equity deal if investor's counsel tries to write in more extensive terms that they're used to seeing in equity docs.

bradleyjg 12y ago

In either the debt or equity case if you simply remove terms they will generally be filled in by defaults based on statute, regulations, and case law. If the issues around equity are inherently more complicated than debt, just settling for defaults doesn't much help. Both sides of the transaction are still going to need to familiarize themselves with those issues. An analogy: most people take the default divorce law instead of writing a prenup, but those default rules are complicated, in many cases more complicated than what the parties would draft. So going with the default can save you time upfront (and awkward conversations) but it isn't generallly a good idea, especially if you opt not to understand what you are agreeing to.

dragonwriter 12y ago
> An analogy: most people take the default divorce law instead of writing a prenup, but those default rules are complicated, in many cases more complicated than what the parties would draft. Of course, prenuptial agreements may be less complex than "default divorce law", but they don't actually reduce the potential complexity of a divorce, because then the complexity becomes the complexity of the prenuptial agreement, compounded by the complexity of the rules governing the validity of prenuptial agreements (outside of restrictions on particular terms), compounded by the complexity of the rules governing the permitted terms in prenuptial agreements and the conditions in which particular terms are enforceable, compounded by the complexity of the default divorce rules (which cover both the areas that cannot be modified by a prenuptial agreement, and any areas left uncovered if the prenuptial agreement, or particular terms, fail.) So the prenup increases both the up-front and tail-end complexity.

zabramow 12y ago

Really interesting question, I'm sure Clev would have a better answer. My guess is that you're going to have a hard time practically speaking getting an investor to sign an equity document without any of the usual terms in those documents.