Convertible Debt, Priced Equity Rounds and Deal Timing
An impromptu Twitter debate arose among Fred Wilson, Dave McClure, Mark Suster, Chris Dixon and others. It was such a good discussion that Fred asked that someone Storify it. I've done that here and expanded it with some additional references, background info and light commentary.
- First, the backstory: On August 31, 2012, Adeo Ressi of Founder Institute and Yoichiro "Yokum" Taku of Wilson Sonsini Goodrich & Rosati introduced new template investment documents for "convertible equity," a structure similar to convertible notes for startup seed financing.
The announcement garnered enough attention that the startup finance wonks among us began chattering immediately on a wide range of media, from TechCrunch article comments to Quora answers and Facebook posts. The main question: Is convertible equity a solution in search of a problem, or is it really something innovative?
Matt Bartus of Cooley published a well-written, balanced analysis on Sept. 5:
Not surprisingly, Ressi himself made the case for convertible equity in his post on the FI blog announcing the documents:
Fundmentally, "Convertible Equity" is a variation on the theme of convertible debt. (See references at bottom for more background on convertible debt, convertible equity and other seed financing structures.)
The conversation in social media widened to reignite the perennial debate about convertible notes vs. priced equity rounds (preferred stock) as the best structure for seed-stage startup financing. Mark Suster of GRP Partners weighed in with this piece:
Fred Wilson wrote his own piece on Sept. 8, reiterating his long-held view that priced equity rounds are the way to go:
As it turned out, Mark is such a whirlwind that he wrote his own blog post later that same day, elaborating on the Twitter discussion below. If you're not pressed for time, though, read on for the unabridged conversation with commentary.
Here is where the interesting conversation began. Dave McClure awoke bright and early this Saturday morning in Honolulu and weighed in, responding to Mark and Fred's commentary:
Dave's point, which is consistent with my own experience, is that seed financing relying on several funding sources, such as angel investors, poses a "herding cats" problem. It's difficult to get the first investor to write the first check — to be the "first penguin in the water," to mix animal metaphors, quoting Dave's tweet below — but once the process picks up steam, others will readily join the round. This is a major reason why the deal documents for a convertible debt financing round usually allow for multiple closings, up to some outside date (such as 90 days).