TimeForBlogging » Startup Funding

Using Convertible Notes for Financing a Startup

Joshua Dorkin — Thu, 18 Mar 2010 04:25:26 +0000

I’ve been doing some research on the use of convertible notes for the purposing of financing our startup, BiggerPockets.com. If you’re also doing research on this financing option, I hope you find the info helpful — if you’ve got some great articles that you want to share, please do in the comments below.

Without further blathering, here are a few articles that I’ve discovered, followed by a key quote from that piece:

What’s The Best Structure For A Pre-VC Investment? – FeldThoughts

Assuming that you are planning on raising VC money some time in the future, there are two different typical structures for the first angel financing: (1) convertible debt and (2) preferred equity.
What are the benefits of debt in a seed round? – VentureHacks

When your business is very young, raising a seed financing ($50K-$500K) via convertible debt is a great alternative to selling equity. Convertible debt is also known as a bridge loan since it ‘bridges’ the company to its next financing.
Raising Money Using Convertible Debt – Entrepreneur.com

To boil it down, using the convertible debt method of financing with family, friends and angels essentially boils down to you saying, “I need money, and you have it. But I don’t know how much my company is worth, so let’s see if professional investors or the passage of time will set the value for us while giving you an upside that’s more in keeping with the risk.”
What Happens If Convertible Notes Are Called By Angel Investors? – AsktheVC.com

One thing to note: don’t personally guarantee angel notes. In that case, the calling of the notes will attach to the entrepreneur’s personal assets and may indeed incentivize investors to call their notes sooner than later.
What happens to the convertible promissory note if the maturity date is reached and there hasn’t been a financing? – startupcompanylawyer.com

The company could either (1) pay back the loan (which is unlikely since it is probably out of money), (2) ask the investors to extend the maturity date, (3) convert the loan into the last round of Preferred Stock (if any) at a pre-determined (i.e. last round) price (or price negotiated at the maturity date), or (4) convert the loan into Common Stock at a pre-determined price (or price negotiated at the maturity date). If the company can’t repay the note, then the investors could push the company into bankruptcy.
Should Entrepreneurs Be Worried About Convertible Notes as a First Financing Event? – AsktheVC.com

Pros: It is much cheaper to consummate a note deal, than a financing deal, which also means it is much quicker to close. Also, you don’t have to lock in a very low valuation today and if you do well the notes should convert into a higher valuation than they would have if you have done an equity deal.
Supersize your debt with these microhacks – venturehacks.com

Note that the company makes the decision to convert the debt to equity—not the investors. This term lets the company avoid defaulting on the loan.
How Do I Do Multiple Closings for an Angel Round? – AsktheVC.com

For a convertible debt round, you can keep it as simple as issuing a promissory note for each investor. This promissory note can contain any special conversion terms, including what happens on a qualified financing (including the definition of the qualified financing), what happens on a sale of the company, and what happens if the company fails. You can do as many closings as you want by simply issuing a separate promissory note for each investor.

Additional reads:

Don’t Just Teach Your Friends to Make Money Online. Partner with Them!

Joshua Dorkin — Mon, 16 Apr 2007 17:24:48 +0000

I recently read a webmaster forum post from a guy whose friends keep asking him to teach them how to make money online. There are a few approaches to take in this situation:

Three Approaches to Dealing With a Friend Who Wants Free Advice on Making Money Online

Tell him to piss off and figure it out himself
Be a good friend and actually help him out
Scare him off by telling him how hard it is

The Fourth and Only Approach to Take In This Situation: Create a Partnership

While I’d typically reccommend the second approach listed above, there is actually a better route to take here. Instead of just giving away all the pearls of wisdom that you spent your hard time learning, do like they do in 24 . . . cut a deal!

How To Create An Online Partnership

Convince your friend of your know-how and let them know that you can relpicate your previous successes
Let them know that while you’d love to just give them all the knowledge you’ve gained, it would be easier if you partnered up
Cut a deal. In exchange for you helping them create a successful online money-making website, you absolutely deserve a cut. It is up to you to negotiate your share based on your ongoing participation in the site, the work you put in to get them started, etc. For example, I’ve partnered with a friend on a blog site, where I am responsible for the setup of the site, maintenance, monetization, and publicity; he is responsible for content. We have come to a 50/50 arangement.
Put everything in writing. Working with friends can lead to problems if expectations are not clear. In creating a contract for this partnership, consider the following questions (this is by no means comprehensive):
- What will each partner’s role be in the day to day care of the website? (consider little things like who wants to be woken up at 3 AM if the is a problem with the site)
- Do you want to create a company, which will own the site, or will it be in your names
- Who will be the registrant of record?
- Who will finance the site’s startup costs?
- How will expenses be covered?
- How will any income/profits be split?
- If sold, how will the proceeds be split?
Once you’ve got everything in writing, be sure there is absolutely no debate over any of the expectations.
Sign your partnership agreement and start making money!

If the online business is a success, you will both benefit. If the partnered site(s) is(are) better then any of your personal sites, then you won’t be kicking yourself in a jealous rage . . . you’ll be laughing all the way to the bank!

Funding a Startup with Angel Investors or Venture Capital

Joshua Dorkin — Sat, 07 Apr 2007 13:05:28 +0000

As a web entrepreneur who has done all his own funding, I have not needed the help of a Venture Capital Firm or Angel Investor. That said, it would be nice to meet and start networking with these guys. Last night I met 2 guys in Denver who are creating their own web startup and we talked a bit about funding. They told me about some companies that are offering young entrepreneurs early capital ($5,000 – $20,000) to get things up and running in exchange for small equity stakes. These programs, they tell me, provide consulting, legal assistance and more! While good for younger guys with smaller need, at this point I’m in need of a bit more then $20,000 in capital to take some of my ideas to the next level.

I discovered and started going through the Angel Investor Directory from Inc. Magazine. It is definitely a good start for anyone doing a VC search. About.com has a good article about how to find an angel investor, which covers 5 key points:

1. Know who you’re looking for.
2. Look close to home.
3. Network, network, network.
4. Realize that many angels don’t fly solo.
5. Use the connection services available on the Internet.

For someone with little VC/Angel Investor knowledge, this is a great start. The piece has some good resources and is worth a look.

On a similar note, I found a great blog post, 7 Tips For Obtaining Angel Investor Funding, that has a few additional points. The main points (you’ve got to read the post to get the full deal) are:

1. Have a Solid Business Plan.
2. Attend Investor Forums.
3. Talk to a Start-up Company That Recently Got Funded.
4. Learn From Each Investor That Says, “No, We Can’t Fund Your Company.”
5. Have a Professional Looking Website.
6. Write Articles to Establish Your Name in Your Particular Field.
7. Join One or More Associations.

These 2 articles have been a great start for me and should be helpful for anyone else starting out in the world of locating startup capital.

Note: As a result of one of the posts, I decided to find a local VC group and will be attending the OpenCoffee Club in Boulder, CO on April 10. I’ll let you know how it goes.