Entrepreneurs love it, investors claim to hate it, but it’s still being used. Why? We’ll tell you, in this interactive Google hangout.
Hear from the experts on the pros and cons of convertible debt.
Check out the slides from this online class
Below are some questions we didn’t get to during the hangout. Thanks to Ben for the answers:
You may or may not get it, so it’s not entirely your choice. There can come a point when the new investors see so much convertible debt come in in on a deal – and remember that this is usually pre-spent money – that it affects the valuation negatively and thus dilutes the entrepreneur’s holding excessively. The reasoning is this: we’re raising new money in order to carry the company to the next value inflection point. All the debt coming in is retrospective, it’s already done its work, so doesn’t actually help build the company going forward, but it still dilutes the deal. The new investors aren’t going to want to cover that, so it comes out of the entrepreneur’s hide. Caps and deeper discounts, of course, exacerbate the problem.
Well, on a debt instrument the entrepreneur’s share is unchanged and governance and restrictive covenants are fewer, so primarily watch the discount and the cap.
I assume by IIR you actually mean IRR (Internal Rate of Return). The discount rate is really not related to the IRR. It’s more a bonus for the investor’s assuming more risk by coming in earlier.
Investors don’t have a set way of valuing companies. NPV is usually nonsense, since it would have to be based on pro-forma revenue projections or theoretical acquisition price. And every investor knows that these are always pie in the sky. Valuation is largely a “wave a figure in the air and see who salutes” operation. Most experienced investors in the area can give you a reasonably accurate range given the stage of a company. Higher valuations are often to be found in Silicon Valley and in Tech Stars companies. Your mileage may vary.
Most investors will tell you that accepting a reasonably priced equity round will make you more marketable.
With my portfolio, looking at the companies that have exited (a small part of the portfolio) I’d say that I’ve been no better or worse off in the debt deals than in the equity deals. An in at least one of those cases I should have participated in the final debt bridge-to-exit in order to see any return. I’ve had several successful conversions to equity as well. I’m actually not allergic to converts, myself, even with one having bitten me badly (and even with that bad bite, I still look to do quite well with the investment, just not twice as quite well!).