Programs Special One-Day Events

December 12, 2013
11:30am – 12:00pm

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.

Ben Littauer – Walnut Ventures, Boston Harbor Angels
Bob Bishop – Goodwin Proctor

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:

  • Is there any situation where seeking convertible debt is bad for startup?

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.

  • Are there any main terms that the entrepreneur should use to protect their own share in the company

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.

  • If I want to determine the valuation of my company, is this 20% discount rate you are talking about a good rate for calculating IIR?

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.

  • On this slide, it said seed stage investment – valuation not understood. Do investors emphasis on IIR only when determinating valuation of the startup? Do they look at NPV?

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.

  • Would seeking convertible debt create problems approaching investors? i.e. investors normally hesitate talking to entrepreneur who has convertible debt?

Most investors will tell you that accepting a reasonably priced equity round will make you more marketable.

  • What percentages of the convertible debt deals you have done don’t work out to the satisfaction of all parties.

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!).


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