Angel investor · Fundraising

Convertible Note: Same terms for everyone?

Brendan Benzing Cofounder at MyNeighbor

December 22nd, 2014

I was just wondering if anyone raising money using a Convertible Note has had a prospective investors ask for changes to the terms of the note, and how they handled it?  Generally speaking it is easier to have everyone with the same terms, but I had a request for an increase in the discount  rate if for some reason the qualified funding wasn't achieved by the maturity date.   
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Michael Brill Technology startup exec focused on AI-driven products

December 23rd, 2014

Most investors are not going to complain if you go back and give them stuff. Having said that, it's work.

Would definitely try to use the others as social proof that the term isn't required and exaggerate the amount of work to "renegotiate" with confirmed investors (btw, you're not renegotiating... the next time you send out an email, just drop a note that they're getting this bonus term - it's kind of a shrug anyway). If new investor still needs it and you still need investor then, depending on your circumstances, I'd point out that there are valid reasons why you'd want to defer an equity round such as you generating enough revenue to defer for higher valuation - should you be penalized for that? "It's important that my investors and I are completely aligned, etc." If that's a reasonable scenario then that should be enough. Even better when delivered with third party validation ("I was talking to an investor that has done a trillion deals and he said he didn't like the variable kicker because he's seen founders push for an earlier financing at worse terms just to avoid this extra dilution."). Less experienced investors tend to put more crap in and often need more experienced investors' wisdom to let it go.

The reality is that if you're 12-18 months down the road, you're running out of money and you're not able to raise money, then you'll need your existing investors to carry you. At that point it's a new deal anyway, so the extra 5% - 10% penalty for missing your funding timeline is completely immaterial. So if you can't move the investor off the term, then take the money, drop in a sentence in a future email to current investors and get back to work.

Steve Simitzis Founder and CEO at Treat

December 22nd, 2014

Looks like the problem is, everyone has the same terms, but now one person wants their own terms. Then what?

You could drop the investor, but let's say you need their money. What options do you have? Do you need to go and renegotiate with everyone else? 

(Brendan, hopefully this captures your question)

Rob G

December 23rd, 2014

1. In general i would remind the investor that it is in everyone's best interest to be sure you and your team are rewarded to succeed, not beaten to a pulp at every turn.  2. If you and your team don't get traction and attract follow-on investment (a priced round) an additional discount isn't going to get his/her investment back and you are going to end up renegotiating the note anyway.  3. dig deeper with the investor to clearly understand what's behind his/her objection/request - selling/negotiation 101- understand the real reason behind the request/objection before offering a solution. Try to configure a solution that aligns investor incentives with yours - where your team and investors get rewarded for hitting goals rather than you getting penalized and investors rewarded for missing them. 

Val Tsanev Founder at CityRaven

December 30th, 2014

My suggestion is for you to not change the terms. All investors need to come in at the same terms, because if they don't they are future implications to the next priced in round that can make not only your current investors but your future investors  very unhappy and contribute to a messy cap table. 

Remind your problematic investor that at this stage of funding the outcome is binary you either all succeed or you all go home, if you do not manage to get a qualifying round by the maturity date of your convertible notes. So whether you get 25% discount vs. 20% discount is almost irrelevant/mute point. Unless the investor is extremely influential, knowledgeable and connected think Dave McClure, Naval Ravikant, Mark Cuban etc. for most other investors money is green for everyone and it is a commodity so you should be able to walk away and find another investor who is willing to come in with the terms that all the other investors agreed on.

Perri Gorman Founder of Archively & UnrollMe

December 23rd, 2014

Hey Brendan - I agree with what is being said too.  First, everyone should definitely be on the same terms. Second what he is asked for doesn't make any sense to me.  On what basis should he get a greater discount because it took longer to get to a priced round?  That kind of mentality sounds like a red flag to me. 

My advice is if you don't know this investor well and you don't need him move on. I wouldn't want an investor like that.  Is he a big part of your round?

Michael Brill Technology startup exec focused on AI-driven products

December 23rd, 2014

I don't think it's an unreasonable ask... and not anywhere close enough in my book to reject them. I think the basic argument is that the discount is a function of time. Let's say that the note actually allows the company to grow and defer equity financing and that in turn raises the valuation which in turn raises the price to the note issuer. The longer it takes, the more it costs - so I should get a greater discount. The logic isn't that wacky... especially if there's no cap. 

Having said that, I imagine 99% of the time a company doesn't raise a round has to do with inability rather than choice... and in those cases this term isn't going to matter much.

averasko

December 30th, 2014

Sure.

The primary reason is that investors tend to defer their investment decisions as much as possible to decrease their risks as much as possible. This is OK from an investor's point of view. This is absolutely not OK from the point of view of entrepreneurs. You might want to incentify those who make their decisions / commitments faster / first and discourage extremely lengthy deliberation. 

I bet your investors know about presence of each other and you have to play the 'fundraising' game to make everyone committed and happy. Think about those who agreed first and those who just 'followed' the crowd.

On the other side, if you are extremely happy with your fundraising and you don't have any issues with getting investors onboard you might not bother with this and give everyone the same terms.

But being able to adjust your terms is something that notes give you and something that you as an entrepreneur CAN use.

Brendan Benzing Cofounder at MyNeighbor

December 23rd, 2014

Michael (Steve thanks for clarifying)

You have captured the issues perfectly! Thanks. Your feedback around the realities of where we likely could be for this issue to be an issue was my thinking exactly, does it really matter?. In fact, it actually could be to my benefit to negotiate now, rather than in the future, when I could be in a weaker position.

Also your point around not being aligned I think makes a lot of sense, because a material change in terms around the discount rate and timing of the funding may actually motivate us to take a worse deal at that time, something I think the investors wouldn't want either.

Rob G

December 24th, 2014

Here's an ingesting read on convertible notes: 

http://www.bothsidesofthetable.com/2014/09/17/bad-notes-on-venture-capital/

Yobie Benjamin Co-founder, COO, CTO, Advisor, Angel Investor, Entrepreneur, Coder

December 30th, 2014

Some notes have MFN clauses which means if there is a change in one, those that have an MFN clause get the same deal.