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Latest key terms in a Convertible Note?

We're planning to issue a standard convertible note to raise $250K to $500K in the coming weeks. Our founding team is comprised of mostly academics with day jobs, so the investment will support web/mobile development, dataset purchases, and marketing expenses. We already have several angels + friends & family lined up, but wanted to educate ourselves on what key Note terms fellow entrepreneurs are seeing, wrt:

-Interest rate (we're planning 8%)
-Conversion terms - we're settting at the next round of institutional funding (Series Seed or A), or upon Change of Control
-Discount - we are considering 20% - 30%
-Valuation cap - we are a pre-revenue company, so are getting pressured to set this at the $5M - $6M range
-Maturity period- considering 12 - 18 months, with option for repayment or conversion to equity

Any other suggestions or advice? Have you had a good/bad experience with a Convertible Note, or encountered any pitfalls for the entrepreneur or angel?

Thanks in advance!
Guy

10 Replies

Brian McConnell
2
0
Brian McConnell Entrepreneur
Head of Localization at Medium.com
While its important that it is structured properly what is far more important is that you do your homework on the moral/ethical character of the counterparties. More likely than not you will hit a rough patch and you will need people watching your back rather than throwing you under the bus. If you are dealing with honorable people the paper is a formality. If you have a seed investor who lacks integrity it can destroy your business. Words of wisdom from someone has been burned by amateur hour investor antics.
Rick Nguyen
1
0
Rick Nguyen Entrepreneur • Advisor
Cofounder @ Spot Trender
Hi Guy, I just closed a decent round of convertible so I can share a bit of my experience: -No such thing as a 'standard convertible note'. Always double check for long term implications (e.g. What would happen if we couldn't raise next round after 12 months, and our company is worth at $2M?) and have a startup lawyer look over the contract before signing. -Deal is not closed until money's in the bank. -It's hard to talk about the specific terms and how good the deal is without knowing more about team, product stage, and market etc. Hope it helps.
Ben Griffin
2
0
Ben Griffin Entrepreneur • Advisor
CEO Peer Group Facilitator | Executive Coach | Board of Directors | Strategic Thinking | Ben.Griffin@CEOIQ.com
Guy, Sounds like you are taking the next big step on a grand adventure - congratulations... You may want to consider this first note issuance in the context of your longer term capital needs, since it's not likely to get you to positive cash flow. The combination of a 20-30% discount + convertibility in 12-18 months is going to make this an expensive round in terms of equity you'll give up or $$$ to repay - If you are thinking we'll need 3-4X this initial raise, in a pre-revenue company at this stage, be clear that there is not going to be much equity left for the founding team by the time you get to a positive cash flow position. Will the 500k get you in a position to generate revenue and have a possibility of repayment (that would tend to mean this much does get you to positive cash flow??) The time horizon of 12-18 months seems really short for a pre-revenue situation - at a 20% discount, you'll be getting a net of $400k (less additional expenses, like legal to paper this deal) and have to put 500k in the bank + interest payments along the way to take out the initial investors in 18 months - does that fit with the business development plan??? Ben Griffin Baltimore, MD Sent to you from Ben's iPad
Vadim Oss
0
0
Vadim Oss Entrepreneur • Advisor
Co-founder at Rentini
Hi Guy,
good luck with the closing. If everything goes the way you predict I think those are reasonable terms for you as co-founder.
However, it's always smart to plan for the worst case scenario and think ahead how your investors will react to that. I would rather set the maturity date as far as possible. 18 months is better than 12 months but make your angels agree. If the Maturity Date occurs and you don't have much traction you may file for an extension with your investors if they are supportive. I imagine you also need a Funding event in case you raise a descent amount of unding prior to the Maturity Date (typically $1M). Early investors like this possibility. 8% are rather at the high end but it's ok. Once again the main thing is to keep everyone happy and you all win.
Richard Rosen
0
0
Richard Rosen Entrepreneur
Founder of FastCall --​> #1 Phone Sales Productivity app in the Salesforce AppExchange
There is tons of info online on Notes vs Equity...

And of course we know nothing of the biz or team.. that said. The valuation cap of $5-$6 M seems high. If this is the first $ in, investors are going to want to see 1/2 that...

That's my first impression w/o know any details.

I have used two Notes both led by 500 Start-ups.
Will Glasson
0
0
Will Glasson Entrepreneur
Assistant County Attorney, Multnomah County
Agree with many of the comments already posted. We closed a convertible note round this Spring but only because we found the right investors and they agreed to the "right" terms. Longer maturity, lower discount, and lower cap were key. Depending on the investors and your growth curve, you might also consider a standard promissory note + warrants. The tax picture is uglier, but it can be an easier transaction.
Guy Marion
0
0
Guy Marion Entrepreneur
Chief Marketing & Revenue Officer at Autopilot HQ
Hi everyone - thank you for the quick feedback. What I took from this is that the quality of our investors, and maintaining supportive/constructive relationships with them, are key. In terms of investment structure, there is no "standard" Convertible Note, but that we are in the ballpark with the terms I listed above, We need to plan for potential Extension if we reach Maturity date and aren't yet cash flow positive. Also need to include a follow-on Funding round (say of $1M or Series Seed) as a Conversion event, since investors will obviously expect this. Lastly, should consider pushing out the Maturity date as long as investors are comfortable (i.e. 18 mo's). Also, the valuation and Founder's dilution at time of the follow-on equity round are important to founders, but even more important should be that our company is positioned for success with investors, cash flow, and adoption.
Bob Pack
0
0
Bob Pack Entrepreneur
ShopJester
the interest can be 4-5% , the discount probably should be 30%--40% at this very early stage.

18 months is OK, add a kicker, like additional 10% discount in the language if you exceed 18 months.

Conversion event can be a Series A round of $IM or more.

most likely these people are close to you, keep them happy.




Neil Gordon
0
0
Neil Gordon Advisor
Board Member, Corporate Finance Advisor and Strategy Consultant
The interest rate, valuation cap and discount are all linked to each other. You're never going to pay the interest that accrues, so it just adds to the dollar amount that's being converted.

I always advise projecting the post closing cap table based on A round assumptions, to see what changes in convertible terms really mean.
Amir Fouad
0
0
Amir Fouad Entrepreneur
Entrepreneur: Founder of Vnu Mngr
thank you all, very helpful information, i have a fully developed SaaS software for $600+ Billion industry, i currently have few clients and i am looking to raise a seed round to expand operation, please get in touch with me to introduces my project
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