Fundraising · Nontraditional Fundraising

[Fundraising] Promissory Notes Vs Convertible Debt?

Joseph Spiro Contract Programmer at 1st Playable Productions

October 23rd, 2015

I'm raising money for an app I'm launching early next year, and most people have advised me to raise the funds as convertible debt with a cap and a discount. One gentleman recently told that he'd prefer seeing us issue promissory notes, which I'm less familiar with. Can someone please explain the difference? What are the consequences to myself and my team if by some chance we are unable to pay back a promissory note?

Max Avroutski Building EV Charging & Electric Energy Access company

October 27th, 2015

@ Steve
I agree that it's not common to see periodic payment requirements of accrued interest on Convertible debt nowadays, but it's very easy to put them there. And that is where danger for novice entrepreneur exists from overbearing or novice investor.

Also, most non-investors i.e. people that don't have vested interest agree that Convertible debt is double dipping by asking for both interest and equity on top of getting to be senior to all equity positions. In contrast, you don't get interest on the money you spent to buy equity in addition to equity itself - that would be ridiculous. So, since Convertible debt is just a transitory instrument to get equity without doing costly or premature valuation then it stands to reason that the application of interest is inappropriate vestige of putting two concepts together a) a "loan" and b) "purchase of equity" and as you know it is being phased out from market in favor of Convertible equity.

Jackson Powell UI/UX Designer & Front End Developer

October 23rd, 2015

Joseph, it sounds like you could benefit from some personalized guidance. Someone like Lonnie Sciambi, an advisor.

Apart from being tried and tested as an investor and entrepreneur like I'm sure the other suggestions are, the benefit of Lonnie is he's accessible to help you on-demand.

He's got a service where you can ask him your toughest question and he'll reply directly with a custom response. Give him a try, it costs you nothing.

David Still Founder of Start-ups, Entrepreneur, Financier and Advisor

October 23rd, 2015

A promissory note (Note) is a signed document containing a written promise to pay a stated sum to a specified person or the bearer at a specified date or on demand. It is a security as are all the other labels like Promissory Notes, Convertible Debt, Preferred etc., etc., etc. The security is repaid with a return on the stated sum (Return). Don't get confused by the words and/or acronyms and/or 'fast chat' used by "experts." There are only three things than can happen to the Return: it goes up, down or stays the same. Regardless of what the Note is called you simply need to know how to calculate how much the Return will cost you under your worst, best and likely case scenarios. The rest of the yatta yatta is hocus pocus to rip you off aka get more of your money. A few KISS, non-inclusive Rules:

  1. NEVER personally guarantee any Note no matter how it is labeled;
  2. NEVER sign a demand Note;
  3. NEVER let a spouse, family member or friend cosign or guarantee a Note;
  4. ALWAYS ask your lawyer how you can structure the Note to be protected by the Uniform Commercial Code; i.e. statute versus common law;
  5. ALWAYS ask your lawyer if a Note is a legal one if it does not have a specified date or is not on demand;
  6. ALWAYS demand that the agreements stipulate that disputes be remedied at the company's expense by neutral binding arbitration - not litigation;
  7. ALWAYS ask the lender/investor to draft sample "if, then" calculations under the relevant covenant in the agreement no matter how much they squeal and tell you "you don't know what you are talking about";
  8. Never let the lender/investor assignor sell the Note without your written permission - not to be unreasonably withheld;
  9. NEVER secure the note with your house or dog;
  10. NEVER sign anything you do not understand regardless of the pressure and embarrassment - feign a heart problem if you have to;
  11. Other

"In tribal times, there were the medicine men. In the Middle Ages, there were the priests. Today, there are the lawyers and investors. For every age, a group of bright boys and girls, learned in their trades and jealous of their learning, who blend technical competence with plain and fancy hocus-pocus to make themselves masters of their fellow men. For every age, a pseudo-intellectual autocracy, guarding the tricks of the trade from the uninitiated, and running, after its own pattern, the civilization of its day." (adapted from Fred Rodell, Yale,Woe Unto You, Lawyers!)

If by some chance you are unable to pay back a promissory note, then your teammates and you will be in hell for a while - just chill, keep fighting, walking and don't give up -you will still be breathing. Also, be careful using the word 'gentleman' until you have seen somewhat act in a reasonable manner when they are about to lose money.

All and all, it's better not to use other people's money particularly when that 'other person' is using 'another person's money'. Trust me.

Fortuna, David

Steve Everhard All Things Startup

October 23rd, 2015

A promissory note is really a negotiable bond which can be traded but returns a fixed interest at a determined time in the future. It doesn't carry a convertible component so must be paid in full on maturity. They typically have a shorter term than convertible debt and the final holder may not be the same as the payor. There can be a complex trail of liability for traded notes but the important thing is that they are short term, with fixed interest and payable at the end of the term.

Steve Everhard All Things Startup

October 23rd, 2015

@ Max Convertibel debt only accrues interest at the conversion rate - it does;t eat into cash flow. I have never heard of convertible debt that requires interest payments during the term. Promissory notes are short term and so it's unlikely that a sale would impact the note. The biggest problem is whether you have cashflow to support repayment as new investors aren't going to be happy that their investment is used for repaying promissory notes rather than growing the business.

David I'm with you regarding using other funds but sometimes it is unavoidable. You should not be using directors guarantees in the US unless the terms are totally amazing. In the UK directors guarantees are standard terms. Transfer of promissory notes is not normally controlled by the maker but by the payor - it is their debt and they can assign it anyway they like.

Mindy Barker Passionate executive working with entrepreneurial companies to improve profitability, value and cash flow

October 24th, 2015

Whether you issue convertible debt or a promissory note - the consequences to you and your team are the same if by chance you are unable to pay back the money you received. If you personally guaranteed the debt or note, you will have a personal debt to satisfy and have a blemish on your reputation as an entrepreneur. If you do not personally guarantee the debt or note, then you personally do not have the debt, but you do have the costly consequence of a blemish on your reputation. Mindy Barker, CPA 904.728.2920 *2016 Small Business Leader of the Year - JaxChamber Health Council* *2015 Partner in Philanthropy Honoree, Jacksonville Business Journal*